Don't Overthink CarMax

The following article is exclusive content from The Motley Fool. While this is typically paid content, we are bringing it to you free because we think it is especially pertinent to your ability to invest wisely. CarMax  (NYSE: KMX  ) investors often ask about the dynamics of the U.S. car market. Below you will hear from one of our newsletter analysts about how that's a frequent question, why investors might be focused on the wrong issue, what macro factors will affect CarMax, and the key issues that investors should focus on.

During the time that I've been writing and talking about CarMax, I've found that investors have a peculiar fondness for trying to forecast the overall U.S. car market. Generally, this leads to wasted time and half-baked theories, and it obscures the more important decision factors related to investing in CarMax.

The proliferation of armchair auto market forecasters
As a matter of context, I've been advocating for CarMax for about 18 months now internally at the Fool. I've pitched it to the Stock Advisor team, various other members of the Motley Fool's investing team, visiting investors, etc. I have even pitched it to hundreds of Fool employees at a companywide meeting. 

During that time, I've gotten a lot of questions about CarMax and the U.S. car market. I've been asked about relative prices of used versus new cars, the cycle for new car sales, the increasing age of the U.S. fleet, general economic sensitivity, etc. Everyone wants to understand the macro dynamics of the car market, and the wide availability of U.S. car statistics has caused a lot of knowledgeable investors to overthink the situation. Everyone wants to be an armchair forecaster of the U.S. car market. 

My bottom line on CarMax and the U.S. car market
Honestly, I think these armchair forecasters are wasting their time and energy. However, since I've been asked these types of questions so many times, I've developed an answer. Here's my bottom line on the subject: I've looked at most of the data points and heard lots of theories, but in the end, I haven't seen anything that structurally threatens CarMax's model of selling late-model used cars. Every argument to the contrary that I've heard has been half-baked at best. However, that's not to say CarMax's business is totally immune to macro factors. 

If there is a recession, the total volume of new and used car transactions will fall. People will freeze up, and CarMax will sell fewer cars. CarMax will maintain its gross profit per vehicle, but with fewer vehicles sold, revenue will fall. CarMax's fixed costs won't change much, so that will result in lower net margins and lower profits. In short, a recession will cause both the business and the stock to suffer. The magnitude of the suffering will correlate with the depth of the recession. In that sense, CarMax is like most other businesses. However, even in bad economic times, I'd expect CarMax to remain profitable, and it's unlikely to fail. This is basically how the "Great Recession" played out for CarMax. 

Foolish takeaways
Successful investing (and decision-making in general) depends on the ability to home in on a few key factors. In the case of CarMax, it's a pretty common mistake for investors to focus on U.S. car-market dynamics. The easy availability of data allows them to overthink the situation and concoct complicated, convoluted theories about the future. Most of those theories will probably be wrong. Instead, I'd recommend that investors refocus their thinking on a few important, answerable questions: For instance: Is CarMax a quality, profitable business? How much can it grow? Is management capable and trustworthy? And is the valuation attractive?

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  • Report this Comment On December 24, 2013, at 11:15 AM, ngmeoy wrote:

    Indeed.... investors tend to misunderstand KMX because there is nothing else like it.... except maybe COSTCO or Amazon. It is a "catefory of one" retailer, with probably the biggest competitive moat of anyone, and an a VERY robust market that is much more stable than new cars....as well as an information-advantage based finance business that give KMX HUGE competitive advantages.

    And instead, many investors get lost in the weeds trying to understand new car sales trends and macro issues. Look at 3,5,10,15 year returns, and ask yourself.... do YOU have anything that has done THIS well ??

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