Avoid the Urge to Go Contrarian on CVNA Stock

Stocks to sell

Speculating in Carvana (NYSE:CVNA) has so far this year been a profitable trade. Changing hands for around $4.81 per share at the market open on Jan. 3, CVNA stock went on a short-squeeze rally during late January and early February.

At one point, shares in the automotive e-commerce company traded for prices nearing $20 per share. Even if you didn’t take profit at that point, and have held on since its recent post-earnings sell-off (more below), you would still be up substantially on your position.

Yet while those with fortuitous timing have profited in a big way by going contrarian on this stock, that may not be the case for those deciding to buy CVNA today. The circumstances that resulted in this big boost for the stock are not likely to repeat themselves later this year.

Instead, a far less favorable outcome may lie ahead.

CVNA Stock, the Squeeze, and the Sell-Off

It’s pretty clear what sent Carvana to the moon and back over the past two months. First, the squeeze. As short sellers piled in and underwater investors cashed out to harvest tax losses, CVNA fell into penny stock territory in the closing weeks of 2022.

Although shorting continued after the start of 2023, the alleviation of tax loss harvesting-related selling pressure was enough to push the stock higher in early January.

Then, in mid-January, when promising inflation figures raised hopes that a pivot on interest rates by the Federal Reserve would arrive during the year, investors made a hard shift from “risk off” to “risk on.”

This resulted in a massive cycling back into speculative growth plays, and CVNA stock was no exception. Because of its high short interest, this sudden inflow had an outsized impact on the stock’s short-term performance. However, like any short-squeeze rally, it came quickly to an end.

Peaking on Feb. 2, the dissipation of this speculative frenzy fueled a steady slide for shares. Then, a sharp sell-off occurred, following Carvana’s most recent quarterly earnings release on Feb. 23. Although shares are finding support again, brace for further declines.

Don’t Count on Another ‘Squeeze Wave’

According to Fintel.io, CVNA stock continues to be heavily shorted. As of this writing, 71.25% of the stock’s outstanding float has been sold short. Yet while this may suggest the potential for another big squeeze, it’s very questionable this will occur.

For one, it wasn’t merely Carvana’s high short interest that sparked the above-mentioned squeeze. The market’s sudden shift to “risk on” was a more material driver. Considering the latest developments with inflation and interest rates, stocks overall may be set for an additional drop, speculative growth plays especially.

Without the help of “meme stock mania,” expect Carvana’s fundamentals to be in the driver’s seat when it comes to price action in the months ahead. Put simply, that’s a scary prospect for anybody holding CVNA today. Why? As seen in the company’s latest financials, things continue to get worse.

Last quarter, Carvana’s revenue fell by 24%, and its net losses for the period ($806 million) represented a more than nine-fold increase from the prior year’s quarter. While the company is working to dramatically reduce operating costs, in order to eliminate cash burn/reach profitability, that doesn’t mean a move to higher prices in it CVNA’s future.

Bottom Line

It’s not a lock that Carvana ultimately files for Chapter 11. However, even if the company avoids this fate, which would cause a total wipeout for the stock, shares could still nonetheless sink to prices well below current levels.

Although CEO Ernie Garcia has stated that the company is not pursuing an additional capital raise right now, it may have to raise more cash via the sale of new shares. It is debatable whether Carvana can successfully right-size the business to profitability, given the extent in which used car demand is dropping.

If cost cuts fail to get Carvana out of the red, and substantial indebtedness (totaling $8.3 billion) remains, a dilutive equity raise may be inevitable. This will place further pressure on shares.

Unlikely to squeeze higher again, and with high downside risk, it’s best to not fight the trend. Stay away from CVNA stock.

On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.