Up 4,300%, but the Biggest Reason to Buy Carvana Was Heavily Overlooked

There are a number of reasons investors might want to buy into used-car retailer Carvana (NYSE: CVNA). One is simply momentum over the past three years, where the stock price has soared 4,300% compared to the S&P 500's 70% gain. Perhaps investors are buying into its more profitable, stable, and healthy growth, rather than growth at all costs from its early years.

Savvy investors perhaps saw something many overlooked during Carvana's fourth quarter that could be the biggest buy signal yet.

Image source: Carvana.

What is "valuation allowance"?

During Carvana's fourth quarter, the company posted a record net income for the full year of $1.895 billion. Savvy investors also noticed the note that reads, "Net income in FY 2025 was positively impacted by ~$685 million associated with the release of our valuation allowance against our deferred tax assets and recording of the full tax receivable agreement liability."

There's a lot to unpack in that one sentence, but let's start with deferred tax assets (DTAs). When a company loses money for an extended period of time, it accumulates DTAs that can reduce future tax obligations. Now, to have tax obligations means you have to have profits, but in the scenario that companies believe there is a greater than 50% chance it will never have the profits to claim these DTAs against, the company is required to set up a "valuation allowance."

Essentially, Carvana's past losses have accumulated DTAs that, in the past, management didn't believe they would be profitable enough to use. This has changed. Because Carvana is now comfortably profitable, and management now sees it as more likely that the company will need to use those DTAs to offset actual income tax obligations, it must release the valuation allowance.

When the valuation allowance is released, it's recorded as a deferred income tax benefit, which immediately increases net income -- the significant benefit of $685 million savvy investors picked up on. While most of this is simply changes on paper and the $685 million benefit is a noncash gain, it is (over time) cash flow positive, as actually using these tax assets will require the company to pay less cash on taxable income in the future.

Don't bury the lead

That entire explanation of Carvana's DTAs and release of its valuation allowance is simply to say that management officially, after complying with rules and regulations that require evidence, believes the company will be easily profitable enough to use these tax assets going forward.

Essentially, it signals the end of a bittersweet era for the company that only three years ago was on the brink of bankruptcy. But this forced the company to focus on reversing losses and doubling down on profitable growth, rather than growth at all costs.

Carvana has bounced back -- if turning a $10,000 investment into more than $430,000 over the past three years wasn't enough of a clue -- and its business is here to stay and is currently thriving. That should continue for investors.

Daniel Miller has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.