Markets

Why Wall Street Loves This Growth Stock

Consumers who have tried to purchase a car this year might know of the present struggles in the auto industry. New cars are almost impossible to come by with dealer inventories down as much as 80%, thanks to shortages of key components like semiconductors.

It has pushed people to change up their purchase strategy and consider used cars too, which has sent prices in the secondhand market skyrocketing. Digital used car dealer Carvana (NYSE: CVNA) has been a big beneficiary, generating record sales and gross margins this year, which have helped push the stock to all-time highs.

There are some short-term risks, but it's no surprise Wall Street has a consensus overweight rating on the stock. Let's explore the details.

A couple sitting at home on their computer, buying a used car online.

Image source: Getty Images.

A booming environment for used cars

In May this year, the rise in used car prices accounted for over a third of the total rise in the Consumer Price Index inflation data. Few people expect to purchase a car and have it rise in value, but that's the experience many used car owners have had in 2021. Naturally, since Carvana keeps an inventory of used cars, it benefited from this development with gross profit rising to over $5,000 per vehicle it sold -- an all-time high.

Semiconductor shortages have been driven by pandemic-related manufacturing shutdowns, and they're the key reason consumers can't get their hands on brand new vehicles.

But the tide has started to turn. In August, the Manheim Used Vehicle Value Index fell to 194.5, which was 18.8% higher year over year. But the index was up as much as 54% earlier this year, so prices finally seem to be tapering off. This drop comes after the University of Michigan consumer sentiment survey revealed that just 38% of consumers thought it was a good time to buy a car in July, the lowest reading in 12 months, and down significantly from the 61% reading in July 2020.

Put simply, sky-high prices have now dampened consumer demand for used vehicles.

It's all about scale

While falling demand doesn't sound like a bullish indicator for Carvana, its strong growth trajectory preceded the unique tailwinds of 2021. The company needed five years to sell its 100,000th retail car. Now, it sells that many in a single quarter. Its rapid growth has launched it up the ranks to become the second-largest used car dealer in the U.S., and it could be on its way to No. 1.

Standing in Carvana's way for the top spot is CarMax, which sold over 1.17 million used retail and wholesale vehicles in its latest full fiscal year. By comparison, Carvana has sold over 447,000 used retail and wholesale vehicles over the last 12 months. But by the end of 2022, Carvana plans to have the capacity to sell 1.25 million vehicles each year.

Carvana's technological prowess might be the key to overtaking CarMax in the near future. CarMax has 228 dealership locations across America, whereas Carvana takes a digital approach and aims to deliver cars directly to consumers following an online purchase. That means Carvana can maintain a small physical retail footprint of just 28 locations across the country, in the form of its quirky, giant car vending machines.

Plus, Carvana has been leveraging artificial intelligence to collect data and monitor the used car market to ensure it keeps the cars consumers demand the most in stock.

A combination of these factors allows Carvana to build scale that might be unavailable to CarMax under its more traditional business model.

Investor takeaway

Carvana has delivered spectacular growth over the last three years, with revenue growing sixfold since 2018. Investors have been rewarded with over 1,000% growth in the stock over the same period.

Metric

2018

2019

2020

2021
(Estimate)

CAGR

Revenue

$1.96 billion

$3.94 billion

$5.59 billion

$12.0 billion

83%

Data sources: Carvana, Yahoo! Finance. CAGR = compound annual growth rate.

In addition to the consensus overweight rating, Wall Street analysts have also attached a $386 average price target, which is 18% higher than where the stock trades as of this writing. But with revenue set to double every couple of years based on Carvana's history of growth, investors with a long-term focus could reap significant rewards.

Buying a car used to be a very personal experience where good sales staff were essential to success. But as we continue to learn, technology makes consumer experiences far more convenient, and it's clear customers are warming up to the idea of purchasing vehicles online and having them delivered to their doorstep.

Carvana presents an opportunity to own a slice of the future, and when we look back in five years, the current share price might be quite the bargain.

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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Carvana Co. The Motley Fool recommends CarMax. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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