Shareholders of The RealReal would probably like to forget the past six months even happened. The stock dropped 39.5% and now trades at $5.28. This was partly driven by its softer quarterly results and might have investors contemplating their next move.

Is now the time to buy The RealReal, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.

Why Is The RealReal Not Exciting?

Despite the more favorable entry price, we're cautious about The RealReal. Here are three reasons why you should be careful with REAL and a stock we'd rather own.

1. Customer Spending Decreases, Engagement Falling?

Average revenue per user (ARPU) is a critical metric to track because it measures how much the company earns in transaction fees from each user. ARPU also gives us unique insights into a user’s average order size and The RealReal’s take rate, or "cut", on each order.

The RealReal’s ARPU fell over the last two years, averaging 5.5% annual declines. This isn’t great, but the increase in active buyers is more relevant for assessing long-term business potential. We’ll monitor the situation closely; if The RealReal tries boosting ARPU by taking a more aggressive approach to monetization, it’s unclear whether users can continue growing at the current pace.

2. Cash Burn Ignites Concerns

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

The RealReal’s demanding reinvestments have consumed many resources over the last two years, contributing to an average free cash flow margin of negative 5.9%. This means it lit $5.88 of cash on fire for every $100 in revenue.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

The RealReal burned through $14.78 million of cash over the last year, and its $366.8 million of debt exceeds the $139.6 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the The RealReal’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of The RealReal until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

The RealReal isn’t a terrible business, but it isn’t one of our picks. Following the recent decline, the stock trades at 21.2× forward EV/EBITDA (or $5.28 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at one of our all-time favorite software stocks.

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