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Don’t get caught by 26% of moving vehicles

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Earlier today, Carvana (CVNA) stock traders returned from the long holiday weekend to find that there were fireworks going on, so to speak. The bears apparently went into hibernation and social media lit up with upbeat posts about Carvana. CVNA shares finished 26% higher today.

Arizona-based Carvana offers an online platform where buyers can buy and sell used cars in the US I’m bearish on the stock.

When the price of an often overlooked stock soars skyward, it’s tempting to jump to the long side of the trade in hopes of quick profits. However, chasing parabolic rallies, especially when they are based more on hype than hard data, can turn your portfolio into a real car wreck.

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Surely, there must have been some positive news about Carvana, something to indicate that the company is about to generate excellent revenue and profit, right?

Do not be so sure. It is up to you, the investor, to filter through the noise and determine what is real and what is questionable. When it comes to Carvana stock, the bulls’ turn in the fast lane could come to an end very soon.

An all day rally

If this were a fireworks show, it would be one that started with a handful of sparklers, and the big detonators wouldn’t go off until later. In fact, Carvana shares opened for trading on July 5 almost flat, barely different from where they closed on July 1.

However, throughout the trading session, Carvana shares continued to rise. From $21 to the day’s closing price of $27.58, the stock gained 26% in value, as mentioned above. Admittedly, it was quite surprising to witness this as it happened.

Typically, this type of price action would be accompanied by some positive news catalyst. However, Carvana’s investor relations news page showed no recent developments. An in-depth analysis of social media posts and popular financial news websites also turned up nothing to justify a 26% rally in the stock price.

There were a couple of analyst price target reductions, but that’s not usually seen as good news. Notably, analysts at Needham lowered their price target on Carvana shares from $80 to $31, while analysts at Wedbush lowered their price target on shares from $90 to $50.

Also, as we’ll see, analysts generally have a moderate buy rating on Carvana stock, which is pretty good, but not something that should send the stock price to the moon.

There’s a lot of worrying news out there about Carvana, but more on that in a bit. First things first: What mysterious force could have caused Carvana’s stock surge? There’s no way of knowing for sure, but it’s possible that marketers on social media sites like Reddit may have been involved.

Rallies based on massive short squeezes tend to fizzle out, so don’t be too surprised if Carvana shares retrace at least part of its gains.

Problems and more problems

If you are looking for reasons to be bearish on Carvana stock, you will have no trouble finding them. First, Carvana’s most recent quarterly financial report showed an EPS figure of -$2.89, which was even worse than the analyst consensus estimate of a loss of $1.44 per share.

Then, at the time of that earnings report, Carvana stated that it intends to raise up to $1 billion through the sale of shares. An injection of capital could be a good thing for the company, but Carvana shareholders should be concerned about the stock price devaluing if the company sells so many.

Those events occurred in April. Moving into May, Carvana announced that it plans to lay off 12% of the company’s workforce, or about 2,500 employees. While that’s bad news for those workers, it’s also not a good sign for Carvana.

Then in June, New Constructs CEO David Trainer called Carvana a “zombie” company, apparently suggesting the company is in serious financial trouble. Scathingly but not inaccurately, Trainer noted that Carvana has a “declining cash supply, intense competition and [an] high valuation” and “has failed to generate positive free cash flow in any year since going public in 2017.”

On top of all that, in July, a report was released alleging that Carvana sold vehicles to its customers before the company actually owned legal titles to those vehicles. The reputational damage from that report alone should be enough to deter cautious investors from holding Carvana stock this year.

Wall Street’s opinion on Carvana

Turning to Wall Street, CVNA shares are listed as a moderate buy based on eight buys, 13 holds and a sell rating assigned in the past three months. Carvana’s median price target is $73.30, implying 165.7% upside potential.

The takeaway: Carvana has poor fundamentals

When a stock glows bright green on your screen, it’s human nature to want to join the bullish party. Social media posts can reinforce this euphoric feeling, until the party is over and you’re done with the bag.

Carvana shares may or may not have risen based on a short adjustment. Either way, the fundamentals simply do not justify an informed and safe investment in Carvana stock now. When the euphoria wears off and reality sets in, some traders are likely to learn a lesson about what can happen when they chase high-flying stocks: The results can be quick and painful.

Divulgation

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