Should You Buy Carvana Stock Right Now?

Investors who bet on Carvana (NYSE: CVNA) stock back in 2023 are now reaping huge rewards. The online used car buying and financing marketplace went through a serious rough patch in 2022 that sent its shares down by 99% from their all-time highs. But for investors who held on, or who bought in when the company's outlook looked dark, the ride since the beginning of 2023 has been nothing short of miraculous. Today, the stock is up by over 5,000% in just over two years.

Though it's still more than 30% below its all-time high, Carvana today is back in the neighborhood of where it traded for the first half of 2021. What really happened with this used car marketplace company in the last two years, and should you invest in it today?

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Image source: Carvana.

Pulling out of a financial hole

Carvana revolutionized used car selling and buying by building an online marketplace and logistics business that bypassed traditional dealerships. Its model was growing rapidly until 2022, when an inflation-induced slowdown hit the automotive sector hard. The company was investing aggressively in its growth efforts right into this downturn, which caused a huge overinvestment in expenses and capital expenditures. Free cash flow reached negative $3 billion on an annualized basis, and the company's debt traded at distressed levels.

Management has worked hard to pull Carvana out of its financial hole. It laid off workers, slashed its marketing budget, and sharply reduced its capital expenditures. After a few rough quarters, this spending discipline worked wonders, bringing the company back to a cash-flow-positive state in late 2023. Capital expenditures remain low -- just $91 million over the last 12 months compared to over $600 million annually at the height of its spending spree.

Now, customers are returning to the used car marketplace due to the superior value proposition it offers. Revenue grew 27% in 2024 to $13.7 billion, with a net income margin of 3%. Free cash flow has remained positive.

A growth question remains

After pulling back from the brink, Carvana is now on solid financial footing once again. The question for investors today is how large this business can be. Carvana sold 416,000 vehicles on its marketplace in 2024, up 33% year over year. That is a lot of used cars, but it's also barely more than 1% of the 39 million used cars sold in the United States every year.

Even if the majority of consumers still prefer to buy and sell used cars at dealerships, Carvana has a long runway for potential growth. Even if it sold 1 million, 2 million, or even 5 million units a year, that would still only be a small fraction of its total addressable market. If it keeps generating positive free cash flow, Carvana should be able to boost its marketing and start convincing more and more people to consider its online marketplace for their used car purchases.

Data by YCharts.

Should you buy Carvana stock?

In order to value Carvana stock, we need to dissect what its profit margins may be at maturity and add its net debt back to the stock's enterprise value -- a necessity when attempting to value heavily indebted companies. With a market cap of $55 billion and net debt of $4 billion, Carvana has an enterprise value of $59 billion today.

Over the long term, management believes it can hit adjusted EBITDA margins of at least 8%. Smart investors know this is a nonsense metric -- net income is a better figure to measure with, and will likely be lower than adjusted EBITDA due to the capital expense needs of the business. Let's assume, to be conservative, that Carvana can hit a 5% net income margin at scale.

A 5% net income margin on its trailing $13.7 billion in revenue would equal $685 million in net income. That would give it a theoretical earnings ratio of 86 based on the current enterprise value. This looks expensive, but what could its ratio be in the future?

If Carvana could grow its retail units sold to 2 million or more annually, its annual revenue could eclipse $50 billion or eventually $100 billion at scale. That may sound farfetched, but it is a target that's well within reach over the next 10 years given the vast size of the used car marketplace.

The problem is, it looks like a lot of this hypothetical potential growth has already been priced into the stock. For that reason, it would be best to avoid adding Carvana stock to your portfolio right now.

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Brett Schafer 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.