When everything seems to be going right for a company, the stock's valuation can soar to levels that are tough to justify. This doesn't mean that the stock is set to plunge, but it does introduce quite a bit of risk for investors. Any bad news, or even "not good enough" news, can trigger a brutal selloff.

Netflix (NFLX -0.74%) and Carvana (CVNA -1.09%) have won over investors, but both stocks are extremely expensive. If you're considering buying either one, tread carefully.

The streaming king

Netflix is entering a new era marked by expanding ambitions. The company has jumped into the live events business in a big way, streaming the Mike Tyson-Jake Paul boxing match last year to over 108 million viewers. This year, Netflix became the exclusive home of WWE Raw.

Live events probably helped Netflix grow its subscriber base in the fourth quarter of 2024. The company added 18.91 million paid subscribers during the quarter, a big increase from the prior-year period. Netflix now has more than 300 million subscribers globally, up from 260 million at the end of 2023.

A price increase will help boost revenue in 2025, although it remains to be seen whether subscribers who joined for a specific live event will stick around. Notably, Netflix will no longer report subscriber numbers in 2025 and beyond, so it will be somewhat difficult for investors to tell what's going on under the hood.

Of course, live events and sports aren't cheap. Netflix generated $6.9 billion in free cash flow in 2024, flat from 2023 despite a 16% revenue jump. The company does see this metric rising to $8 billion in 2025, a forecast that factors in $18 billion in cash content spending.

While Netflix is performing well, the valuation is getting a little out of hand. The company is now valued at about $416 billion, which puts the price-to-free cash flow ratio using the company's 2025 guidance at 52. That's rich for sure, and it's difficult to see how Netflix can grow quickly enough to justify such a lofty valuation.

A high valuation doesn't mean the stock is going to drop, but it does set the bar high. Any disappointment coming from the company's quarterly reports this year could do a number on the stock price.

An unlikely comeback

Used-car marketplace Carvana has managed to pull off a comeback that looked almost impossible. The company struck a restructuring deal with lenders in 2023 that looked like a desperate attempt to avoid a liquidity crisis. The deal involved exchanging debt for new debt with interest for the first two years paid in the form of yet more debt. In year three, interest payments would revert to cash at a 9% rate.

This deal bought Carvana some time, and the company has taken advantage and made considerable progress. Retail unit sales have largely recovered, although they're still below peak levels, and gross profit per vehicle has soared. Carvana is now producing a small positive net income, and free cash flow has surged thanks to the lack of cash interest payments.

Things will get trickier on the cash flow front once cash interest payments resume, but it's clear that Carvana is in a much better financial position today than it was in mid-2023. However, none of this can justify the stock's soaring valuation.

Carvana is valued at $28 billion, which is more than twice the average analyst estimate for 2024 sales and over 160 times the estimate for earnings per share. For comparison, CarMax is valued at less than $13 billion despite generating about twice as much revenue as Carvana. CarMax trades for less than half of annual sales.

Of course, Carvana is back in growth mode, but the used car market can be volatile and unpredictable. A slowdown could wreak havoc on the company's finances just as it prepares to resume cash interest payments, for example. While Carvana's finances have improved, the company still looks fragile.

With a valuation in the stratosphere, Carvana stock could get hammered if anything at all goes wrong for the company.