Over the last six months, CarMax’s shares have sunk to $39.22, producing a disappointing 10.6% loss - a stark contrast to the S&P 500’s 6.1% gain. This might have investors contemplating their next move.
Is now the time to buy CarMax, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think CarMax Will Underperform?
Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons we avoid KMX and a stock we'd rather own.
1. Shrinking Same-Store Sales Indicate Waning Demand
Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.
CarMax’s demand has been shrinking over the last two years as its same-store sales have averaged 1.3% annual declines.
2. Low Gross Margin Reveals Weak Structural Profitability
We prefer higher gross margins because they not only make it easier to generate more operating profits but also indicate product differentiation, negotiating leverage, and pricing power.
CarMax has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 6% gross margin over the last two years. Said differently, CarMax had to pay a chunky $94.02 to its suppliers for every $100 in revenue. 
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
CarMax’s $18.54 billion of debt exceeds the $122.8 million of cash on its balance sheet. Furthermore, its 18× net-debt-to-EBITDA ratio (based on its EBITDA of $1.03 billion over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. CarMax could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope CarMax can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
CarMax falls short of our quality standards. After the recent drawdown, the stock trades at 17× forward P/E (or $39.22 per share). This multiple tells us a lot of good news is priced in - we think there are better stocks to buy right now. Let us point you toward one of our all-time favorite software stocks.
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