Summary
- Carvana, which is fighting to avoid bankruptcy, has seen its stock price soar in recent days.
- Carvana has an abnormally high short interest ratio which is fueling speculation of a massive short squeeze.
- Underlying business issues are not resolved and Carvana remains, despite a soaring stock price, at risk of going out of business.
Shares of used-car dealer Carvana (CVNA) have soared in 2023 due to growing popularity of Carvana's ticker on the WallStreetBets forum on Reddit which fueled speculation about the possibility of a short squeeze. Carvana is the most heavily shorted stock on Wall Street and Carvana's stock rally can be compared to other meme stock rallies that occurred in the last couple of years. Although the short interest rate for Carvana is abnormal, I believe the risk is enormously high at this point and investors should try to avoid the short squeeze trap that is set up here!
Carvana background and core business challenges
A few months ago I submitted my work on Carvana to Seeking Alpha, Carvana: The Writing Is On The Wall , which discussed the used-car company's high bankruptcy risk due to multiple business problems that Carvana was dealing with at the time.
These risks included a pandemic boom in used-car sales that was fizzling out, unsustainably high SG&A expenses as a percentage of total sales as well as a bloated balance sheet that made a bankruptcy filing highly likely. Carvana has not been able to adapt to a changing post-pandemic business environment , chiefly falling used-car prices which resulted in negative revenue growth and EBITDA margins in the third-quarter. As is often the case with meme stocks that start to gain traction on Reddit's WallStreetBets forum, Carvana has a struggling business and a highly shorted stock... two top requirements for retail investors trying to orchestrate a short squeeze.
High short interest ratio
According to highshortinterest.com , Carvana is a highly shorted stock: the short interest ratio for Carvana is 59.65% which makes it by far the most heavily shorted stock on Wall Street. The second most heavily shorted stock is that of Bed Bath & Beyond which only recently announced that it was closing 87 Bed Bath & Beyond stores and the company, according to Reuters , was recently said to be preparing for bankruptcy.
Companies with short interest ratios above 20% are typically considered heavily shorted and the list above includes troubled retail chains like Bed Bath & Beyond, but also electric vehicle start-ups and drug manufacturers. Usually, these companies struggle to achieve a baseline of profitability, face market headwinds or some structural issue.
The meteoric rise in Carvana's stock price this year is likely, in part, related to the unwinding of short positions which have accumulated in recent months. As you can see in the following chart, the number of Carvana shares sold short has consistently increased as the company disclosed deeper problems in FY 2022 and the stock price dropped as a result.
Reasons to be cautious
I am warning against buying into Carvana's current stock surge as short squeeze bubbles tend to get picked at some point which exposes investors chasing the stock price here to the risk of incurring massive losses. Recent examples of short squeezes strongly suggest that investors are at risk of losing a significant portion of their investment capital as all short squeezes ultimately fizzle out.
GameStop ( GME ), AMC Entertainment ( AMC ) or Bed Bath & Beyond (BBBY) have all seen major short squeezes in recent years as retail investors banded together on WallStreetBets and egged each other on to buy the firms' stocks in order to force the closure of short positions. A lot of people who bought into the short squeezes of GameStop and AMD have been seriously burned as the inflated valuations proved to be unsustainable.
Risks with Carvana
The biggest risk for Carvana is still that the company is locked into a business model that is fundamentally not profitable. As a result, there is a high chance that Carvana won't survive and go into bankruptcy, potentially wiping out the remaining shareholders. Investors that are buying into the struggling used-car dealer in the hopes of profiting from an even bigger short squeeze may suffer a complete loss of investment capital.
Final thoughts
Investors should think twice before they jump into Carvana at this point and realize that they are buying into a business that is widely expected to go into bankruptcy... which is why Carvana's stock has lost like 90% of its value in the last twelve months. While the short interest ratio is extremely high at ~60% - which indicates that more short position could be dissolved as Carvana's share price rises further - I believe investors are ultimately dealing with yet another short squeeze trap. These traps lure investors into the stock of a struggling business that is teetering on the brink of bankruptcy in the hopes of achieving gains from forced closures of short positions. While a few early, speculative investors already made some good money here, the majority of investors jumping into CVNA to profit from an even bigger short squeeze are likely to get burned. As is always the case when it comes to short squeezes: they don't tend to end well for a lot of investors!
For further details see:
Carvana: Short Squeeze Trap