Value proposition

The Challenge of Declining Profits The CarMax Value Proposition

  • CarMax shares drop sharply after reporting lower earnings
  • Consumers vote with their wallet
  • If the Worst is Baked, KMX Stock Begins to Be Properly Priced

The used car dealership CarMax (NYSE:) disappointed investors with a lemon of a . The company posted weaker-than-expected revenue. But the main figure was the company’s declining profits. The company reported earnings per share (EPS) of 79 cents, nearly 50% below analysts’ average estimate of $1.40 per share.

Unsurprisingly, KMX shares are down 23% at midday after the report. This brings the loss since the beginning of the year to almost 50% for the title. This is particularly troublesome as the stock was already underperforming the market as a whole.

But that’s no surprise to most investors, and certainly not most consumers. Used car prices were one of the first indicators of rising inflation. And with inflation likely to remain sticky for some time, consumers are taking matters into their own hands.

It might take a while

Since the earnings report, some analysts are proclaiming that the used car boom is over. It may be true. But I don’t know if that will give used car buyers much relief in the short term. Like inflation itself, used car prices may not go up, but that’s not the same as going down in price. This is unlikely to happen right away. And there are two important reasons for this.

First, the auto industry still faces an imbalance between supply and demand. Therefore, in situations where buying a new car is a necessity rather than a benefit, consumers are likely to face high prices for some time to come.

Second, if you take the Federal Reserve at its word, interest rates will continue to rise through 2023. This means that many consumers who are market-excluded will remain market-excluded. And unfortunately, this may mean that more consumers will be overpriced.

I will also offer a bonus reason. People considering financing a vehicle may find that, if they can afford it, the difference between a new vehicle and a used vehicle (in terms of monthly payments) can make buying a new vehicle more cost-effective.

Is the worst over for KMX Stock?

Investors and consumers should be careful not to miss out on the bulk of CarMax’s profits. The company has created a more efficient way to sell cars. It’s not going to go away. But efficiency cannot overcome all barriers to purchase.

And this efficiency comes at a cost. The company said its general and administrative expenses rose 18% in the quarter due, in part, to investments in technology. While these are likely to pay for themselves, the company’s results show it doesn’t matter how easy it is to buy a car if the demand isn’t there. . And the price remains the most important factor.

That being said, CarMax is still expected to grow revenue over the next five years, albeit at a much slower pace than in the past two years. But that is likely to dampen profits, which are expected to decline on average about 3% over the next five years.

I do not own or plan to own KMX stock. But if I was considering it, that would be the question I would ask. If so, you might point to an attractive price/earnings ratio of around 11x earnings as a reason to watch the stock. However, it is still higher than AutoNation (NYSE:) which has a P/E ratio of around 4x earnings and just saw its all-time high.

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