RACING

Don’t Get Caught in the 26% Drive-By Rally

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Earlier today, Carvana (CVNA) stock traders returned from the holiday long weekend to find there were fireworks going on, so to speak. Apparently the bears went into hibernation and social media lit up with bullish messages about Carvana. CVNA stock ended up 26% today.

Carvana, headquartered in Arizona, provides an online platform where buyers can buy and sell used cars in the United States. I am bearish on the stock.

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When the price of a typically under-the-radar stock soars, it’s tempting to jump to the long side of the trade in hopes of quick gains. However, chasing parabolic rallies, especially when they’re based more on hype than hard data, can turn your wallet into a real car wreck.

Surely there must have been some positive news about Carvana, something indicating that the company is on the verge of generating tremendous revenues and profits – right?

Don’t be so sure. It’s up to you, the investor, to sift through the noise and determine what’s real and what’s questionable. As for Carvana stocks, the bullish turn in the fast lane may end very soon.

A one day rally

If it was a fireworks display, it would be the one that started with a handful of sparklers, and the big blasters wouldn’t come out until later. Indeed, Carvana stock opened on July 5 almost flat, barely different from where it closed on July 1.

Yet throughout the trading session, Carvana stock kept rising. From $21 to the day’s closing price of $27.58, the stock gained 26% in value, as previously mentioned. It was, admittedly, quite amazing to witness this as it happened.

Typically, this type of price action would be accompanied by a catalyst of positive news. Still, Carvana’s investor relations information page showed no recent developments. A thorough analysis of social media posts and popular financial news websites also failed to reveal anything that would justify a 26% rise in the stock price.

There have been a few price target cuts from analysts, but that’s not generally seen as good news. In particular, analysts at Needham lowered their price target on Carvana stock from $80 to $31, while analysts at Wedbush lowered their price target on the stock from $90 to $50.

Also, as we will see, analysts generally have a Moderate Buy rating on Carvana stock, which is pretty good, but not something that should send the stock price sky high.

There’s a lot of disturbing news about Carvana – but more on that in a moment. First, what mysterious force could have caused the sudden increase in Carvana’s stock? There’s no way to know for sure, but it’s possible that short-term traders on social media sites such as Reddit were involved.

Rallies based on massive short cuts tend to fizzle out, so don’t be too surprised if Carvana stock retraces at least some of its gains.

Problems and more problems

If you’re looking for reasons to be bearish on Carvana shares, you won’t be hard pressed to find them. First, the latest quarterly financial report released by Carvana showed an EPS figure of -$2.89, which was even worse than analysts’ consensus estimate of a loss of $1.44 per share.

Then, around the time of this earnings report, Carvana said it intended to raise up to $1 billion by selling shares. A capital injection could be good for the company, but Carvana shareholders should worry about the stock price devaluing if the company sells that much.

These events took place in April. Moving into May, Carvana announced plans to lay off 12% of the company’s workforce, or around 2,500 employees. While this is bad news for these workers, it’s not a good sign for Carvana either.

Then, in June, New Constructs CEO David Trainer called Carvana a “zombie” company, apparently suggesting the company was in serious financial trouble. Scathingly but not inaccurately, Trainer pointed out that Carvana has a “dwindling cash pool, intense competition and [an] high valuation” and “has failed to generate positive free cash flow in a year since its IPO in 2017”.

On top of all this, in July a report emerged alleging that Carvana sold vehicles to its customers before the company actually owned the legal titles to those vehicles. The reputational damage in this report should be enough to dissuade cautious investors from owning shares of Carvana this year.

Wall Street’s view of Carvana

As far as Wall Street is concerned, CVNA shares are in moderate buy form based on eight buys, 13 takes and one sell rating assigned over the past three months. Carvana’s average price target is $73.30, implying an upside potential of 165.7%.

Takeaways – Carvana has bad fundamentals

When a stock flashes bright green on your screen, it’s human nature to want to join the bullish party. Social media posts can reinforce that euphoric feeling — until the party is over and you end up holding the bag.

Carvana stock may or may not have rallied based on a short squeeze. Either way, the fundamentals simply do not justify an informed and confident investment in Carvana shares now. When the euphoria wears off and reality sets in, some traders will likely learn a lesson about what can happen when chasing high-flying stocks – the results can be quick and painful.

Disclosure

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