Is This the Fastest-Growing Tech Trend of the 2020s?
By Mon, Nov 30, 2020
Disruption equals profits. That’s a simple formula to find new investing opportunities in so many industries. Switchboard operators were “disrupted” by automated phone systems, the personal computer caused profound disruption for typewriter companies. And now in 2020, the entire way of selling cars and trucks is undergoing the next wave of disruption.
And the stakes are huge. The Bureau of Economic Statistics pegs the U.S. retail auto market at around $218 billion each year. Edmunds, an online resource for automotive information, figures that every car sold brings in a $1,000 profit for each dealer, and $200 for each salesman. When we’re talking about an industry that moves 17-20 million units per year, those kinds of profits add up.
Right about now, you may be thinking we’re talking about shiny new cars with just a few miles on the odometer. Yet, the used-vehicle market in the United States is more than twice as large as the new-car market on a unit-sales basis. And that’s precisely where the true industry disruption is taking place. According to Statista.com, 40.8 million used cars and trucks were sold in the U.S. in 2019. Better still, used cars can bring in $4,000 in gross profits per vehicle, once they are spruced up and re-conditioned for sale.
These days, a growing number of those cars are being sold online — sight unseen. Consumers are using the internet to find their ideal car at the ideal price, and really feel little need to take such cars out for a test drive. To give you a sense of just how quickly this new trend has taken root, take a look at the growth trajectory for Carvana (CVNS). This online purveyor of gently used cars has seen its shares more than double in each of the past four years. And in 2021, sales should retain a strong head of steam, rising more than 45% to around $7.85 billion.
Investors were initially slow to catch on to this great growth story. Shares of Carvana rose from around $20 in June 2017 to $55 by this past March. Since then, they have been on a tear, surging to a recent $240. Trouble is, Carvana continues to bleed cash. Analysts at Bank of America suggest that Carvana won’t generate positive operating profits until 2022, by which time the firm should generate $140 million in positive cash flow. Shares trade for more than 230 times that figure, on an enterprise value basis. How high is that multiple? Even tech industry darling Apple (AAPL) trades for a more reasonable 22 times projected 2022 operating profits.
While Carvana trades near all-time highs, rival Vroom (VRM) offers a more appealing risk/reward proposition. At a recent $37, shares trade for half of their 52-week high.
Vroom has been public only since June of this year, and its lack of a long track record as a publicly-traded stock means it’s not nearly as well-known as Carvana, which has seen its shares trading since April 2017.
While it’s too soon to gauge what level of operating profits Vroom will have by 2022, we do know that the company’s stock is far cheaper than Carvana’s stock by one key metric: Vroom’s enterprise value (EV) (which is market value plus debt minus cash) is slightly lower than its projected 2022 revenue of $3.9 billion, while Carvana trades for more than four times that sales figure, on an EV basis.
Vroom has also been a laggard on the growth curve but is now playing catch-up to Carvana. As noted, Carvana is expected to grow around 45% next year. Yet Vroom is poised to grow more than 80% as it moves into lucrative value-added services such as extended warranties and auto financing.
The key to success for these firms is their ability to get access to enough used cars that are in good condition. This summer, there was a mad scramble for such vehicles as consumers opted to buy used rather than new in uncertain times. On a recent conference call, Carvana execs noted that building a supply of cars to re-sell remains a tough challenge. In contrast, Vroom has been able to boost its inventory of vehicles from under 2,000 in May to 12,000 now. As analysts at Bank of America recently noted, “Vroom’s inventory ramp positions them well for revenue growth above industry.”
There is another catalyst in place here for patient investors. After Vroom’s June 2020 IPO, company executives and key employees were restricted from selling shares, in what is known as a “share lock-up.” Around December 3 or 4, that lock-up period will expire, and shares may see a bit of selling from insiders. That’s always the perfect time to pounce — when shares are seeing selling pressure for reasons not related to the health of the business. This is a stock to monitor and get ready to buy when shares drift lower on much higher volume in early December.
Action to Take: Consider buying shares of Vroom (VRM) under $40 and selling when they reach $70.
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About the Author
Contributor David Sterman is a certified financial planner and has worked as a financial journalist and investment analyst for more than 25 years.
