The tables have clearly turned for Carvana (CVNA 8.79%). After the stock tanked 98% in 2022, this used car e-commerce company's shares are up a whopping 468% in 2023. That return trounces the Nasdaq Composite's 30% gain. But can this high-risk growth stock make you richer over the next 10 years? Let's see.
Tremendous upside
In 2022, Carvana sold 412,000 used cars, up from 44,000 just five years earlier in 2017. Revenue during this period skyrocketed almost 15-fold. There are usually 40 million used car transactions in the U.S. in a typical year, a figure that doesn't change much.
This means that not only has Carvana quickly gained market share, it still only represents a very tiny portion of the overall industry. So there is definitely a huge opportunity ahead. Before the stock started cratering toward the end of 2021, investors certainly fell in love with this incredible growth story.
Most people aren't very fond of the traditional means of buying a used car. The process can take hours, inventory is usually limited to what's available at that location, and then there's having to haggle with a salesperson. As online shopping proliferated, it's not surprising that this means of buying goods translated to automobiles. Carvana offers a huge nationwide inventory, free delivery, and financing options all from the comfort of one's home -- and a transaction can be completed in minutes. It truly is game-changing.
With shares currently still down 93% from their all-time high, Carvana's stock only sells at a price-to-sales (P/S) multiple of 0.2. That's well below its historical average P/S ratio of 1.2. More than half of the outstanding shares were sold short (as of June 15), a clear indicator of the pessimism surrounding the stock. That could present a buying opportunity for some daring investors.
There are major risks
Carvana's disruptive attributes and growth potential are certainly compelling reasons to own the stock. But there are also key risks to keep in mind.
The most glaring reason not to buy shares is the company's unfavorable financial situation. As of March 31, Carvana had $6.8 billion in long-term debt on its balance sheet, compared to just $488 million of cash and cash equivalents. Perhaps even more alarming, the business made $159 million in interest payments during the latest quarter. Carvana generated $366 million of gross profit in the first quarter, so it would be an understatement to say that its finances are tight.
Moreover, last year showed just how dependent Carvana's success is on a robust macroeconomic backdrop. Because people generally finance their car purchases with auto loans, low interest rates benefit the company because it makes these purchases more affordable. The Fed's rate hikes threw a curveball. And when inflation is at elevated levels, and people are forced to spend more on essentials, there is less buying power for a big-ticket item like a car.
Carvana also has to worry about used car prices across the industry. On one hand, higher prices mean more revenue potential, which can lead to higher gross profit per unit sold. But on the other hand, this could also discourage people from buying because prices might be too expensive. The problem is that these factors are mostly outside of the company's control.
To its credit, the management team has focused relentlessly on cutting costs and getting the business back to posting positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). They expect this figure to come in at $50 million for the current quarter, which would demonstrate progress in the right direction.
There's no question that Carvana has huge upside, but the risks deserve a lot of attention. Investors need to figure out if the return potential is worth it. If Carvana is able to successfully navigate the uncertain economic environment and get back on the hypergrowth trajectory it was on before 2022, then shareholders could be rewarded over the next decade.
