The Online Car Market Is Heating Up. Why an Analyst Says to Buy Vroom Stock and Sell Carvana.
Carvana stock trades for more than 12 times estimated 2022 gross profit.
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Keybanc has a pair trade for investors to consider.
On Wednesday evening, analyst Edward Yruma upgraded shares of online car seller Vroom (ticker: VRM) to Buy from Hold while downgrading shares of online car seller Carvana (CVNA) to Hold from Buy. He isn’t too bearish on Carvana, but he believes investors can arbitrage the valuation gap between the two.
Vroom stock is getting a bump from the upgrade. Shares rose about 6.7% in Thursday morning trading. The S&P 500 and Dow Jones Industrial Average are up about 0.8% and 0.6%, respectively. Carvana stock rose 2.6%.
“We remain highly constructive on the used auto retailing space given still-constrained new auto availability,” wrote Yruma in his research report. “We think [Carvana] is attractive long term given its consumer offering, but we believe that the space will have a number of national scaled alternatives.”
Competition is coming, and Vroom is one of those competitors. And its stock trades for roughly two times estimated 2022 gross profit. Vroom isn’t profitable yet, so a Yruma uses a multiple of gross profit.
Carvana, on the other hand, trades for more than 12 times estimated 2022 gross profit. There is more than a 10-point valuation gap.
One of the reasons for the gap is that Vroom stock has had a dreadful year. Shares are down about 80% over the past year, leaving it with a market capitalization of about $1 billion. Carvana stock hasn’t done great either, but it has performed better than Vroom. Carvana shares are down about 40% over the same span; the company has a market cap of more than $30 billion.
A pair trade, essentially, seeks to profit from the relative performance of one company versus another. The market going up or down should, in theory, affect both stocks similarly. Making money on a pair boils down to one company outperforming another.
For Vroom, the company “has made a number of steps to improve the consumer experience, which we think will drive higher relative performance,” wrote Yruma. He also believes Carvana is likely to step up capital spending, which could hurt investor sentiment. Investors tend to prefer improving free cash flows.
A pair trading typically involves going long one stock and shorting, or betting against, the other stock. Shorting stocks isn’t for everyone; it entails borrowing and then selling shares, in hopes that the stock will fall. It requires constant checking in on the trade—it is an active stock market strategy compared with a passive, buy-and-hold strategy.
A pair trade can also be accomplished using options, such as buying a call on Vroom and a put on Carvana. A call option gives the holder the right to buy a stock at a fixed price over a defined period. It’s a bullish position. A put gives the holder the right to sell a stock at a fixed price. Puts become more valuable as the stock referenced by the option drops. Options trading is more complicated than shorting, but it’s another way to accomplish the pair.
It’s also possible to just buy Vroom stock. Yruma’s price target is $13 a share, roughly 75% higher than current levels. He doesn’t have a target price for Carvana stock, which means it should keep up with the overall market.
With the Vroom upgrade, 67% of analysts covering the stock rate shares Buy. The average Buy-rating ratio for small-capitalization stocks is about 65%. About 58% of analysts rate the larger Carvana stock a Buy.
Write to Al Root at [email protected]
