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Why Carvana Shares Popped 15% Wednesday

What happened

Shares of Carvana (NYSE: CVNA), an online car buying and financing platform also known for its giant car vending machines, were surging 15% higher Wednesday with no direct news about the company. Here's why a short squeeze could be happening.

So what

Carvana has been an intriguing company from the get-go, and its soaring stock has made it even more interesting. It's up 881% in just under three years as a publicly traded company. While that's made many investors happy, it's also brought out plenty of short interest.

When short-sellers borrow and then sell a company's stock at what they believe to be an overvalued price, they're required to buy those shares back later. If the short-sellers later believe they made a mistake as the stock they shorted continues to rise, they could buy the shares back in a panic to avoid further losses.

As short-sellers cover their position, the short-term boost in demand will propel Carvana's stock higher -- 54% of Carvana's float is sold short, and its short interest ratio is approaching 12. Here's a detailed breakdown of how those two ratios work, but suffice it to say there is plenty of short interest for a short squeeze to be happening Wednesday. Short-sellers might be concerned that Carvana's Feb. 26 fourth-quarter earnings results could send its shares even higher, a risk some aren't willing to take.

One of Carvana's car vending machines. Image source: Carvana.

Now what

Carvana is currently focused on expanding its business quickly, and it's been successful. In its most recent quarter, it reported retail units increased 83% compared with the prior year, and it recorded its 23rd consecutive quarter of triple-digit revenue growth.

But Carvana's rapid growth is expensive, and investors will eventually want to see the company take steps to turn a profit. Investors should take short squeezes, and similar drops, with a grain of salt. Carvana is a young company with immense potential, albeit in a competitive industry. And there will be a decent amount of uncertainty as its top line continues to expand rapidly and its losses continue to mount.

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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.


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