The rally in Carvana (NYSE:CVNA) truly has been incredible. After plunging during the market’s panic in March, CVNA stock has gained 450% from its lows, and trades at an all-time high.
On its face, the rally seems like far too much. Carvana is unprofitable. The coronavirus pandemic disrupted its business, as it did so many others. Effects may linger for the rest of the year, if not longer.
And yet CVNA stock is now up 34% so far in 2020. It has a market capitalization over $20 billion. Incredibly, Carvana is now more valuable than CarMax (NYSE:KMX), whose revenue is almost five times as large.
I don’t think that knee-jerk reaction is quite right. Investors can’t make the same mistake now that the market did in March: focusing on short-term disruption while ignoring long-term potential. Carvana has real long-term potential.
Still, I’m sympathetic to valuation concerns after this rally. Carvana’s business model is intriguing, but unproven. A new rival just went public. And I wonder if investor attention will move elsewhere in the next few months. CVNA stock has a path to upside over the long haul, but it seems like the easy money has been made.
The Case for CVNA Stock
The case for CVNA stock at its core is simple: the company has the potential to revolutionize the used-car industry. And that industry is massive.
Used-car sales in the U.S. totaled $841 billion in 2019. Carvana’s trailing twelve-month revenue of $4.3 billion suggests it has roughly one-half of one percent of the market. Obviously, there’s a long runway for growth just in the U.S. Presumably, Carvana at some point could move into overseas markets as well.
In this market, an opportunity like that has been enough for upside, particularly when paired with solid execution. And Carvana has executed impressively. Revenue doubled in 2019, after rising 128% the year before.
It’s true that Carvana isn’t profitable. But it shouldn’t be. Again, there’s a huge opportunity to take market share.
At the end of 2019, according to the company’s Form 10-K filed with the U.S. Securities and Exchange Commission, Carvana locations serviced about two-thirds of the U.S. population. There’s room for greater footprint expansion, while many potential customers likely aren’t yet aware of the brand, or its online shopping options.
Valuation is not a reason to ignore a stock like this. Carvana is a disruptor. And disruptors, whether Carvana or Tesla (NASDAQ:TSLA) or Zoom Video Communications (NASDAQ:ZM), are not going to be cheap.
So I wouldn’t steer investors toward selling CVNA stock solely because it’s expensive. I certainly wouldn’t recommend anyone try and short the name, even though half the float is sold short at the moment.
Does the Business Work?
As attractive as the business is, however, there are some concerns with the stock.
Most notably, Carvana hasn’t proven itself yet. The reason that half the float is sold short isn’t just because Carvana’s stock is expensive. Most short sellers are wise enough not to short on valuation alone. (Many of those who weren’t have been chased out of the market.)
Rather, bears believe the business model doesn’t work. They would argue that there are reasons why CarMax, the largest used-car dealer in the country, only has market share of less than 3%. The industry is fragmented not because no one has thought to consolidate it, but because small, local dealers have an edge in some ways over large, faceless corporations.
I don’t believe that’s necessarily the case. But Carvana still has to prove otherwise. It’s most likely that the company is unprofitable because it’s investing in growth. It’s at least possible, as bears would claim, that its structural costs are simply too high.
Bears don’t have to be proven right immediately. After a 450% rally, any sign of weakness, of basically any kind, can tank CVNA stock.
The name obviously has taken its place as a pandemic play. That, plus the rally leaves no room for error over the rest of the year.
Will Investors Look Elsewhere?
At the very least, that does create competition for growth investor dollars that might have gone to CVNA stock. (To be fair, Vroom’s initial public offering has done nothing yet to dent the optimism toward Carvana.)
More broadly, Vroom’s IPO is one more near- to mid-term risk to a stock that, again, has more than quintupled in barely three months. Those risks seem to be piling up.
CVNA needs broader optimism to hold. It needs earnings in the second half of the year to be almost perfectly on point. And it needs the pandemic to stay front and center in investors’ minds enough that they don’t pivot to more challenged sectors like travel and restaurants.
It seems like a lot to ask in the short term. And so even investors bullish on the long term should consider the possibility that the market provides a more attractive entry point in the not-too-distant future.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.