Prior to the pandemic, CarGurus (CARG -2.39%) was making a name for itself as an online platform that connects automotive dealers and buyers. In 2019, the company grew revenue 30% and achieved a gross margin of 94%. Add to that the fact that the company was net income and cash flow positive, and CarGurus was worth a look for investors.

The pandemic put a pause on that momentum, but a recent acquisition has resulted in more revenues and profits and should be a catalyst for growth moving forward.

A person sitting in their car uses their cell phone while leaning out the window.

Image source: Getty Images

Subscriptions leads the way

CarGurus revenue primarily comes from marketplace subscriptions. Car dealers choose from multiple types of subscription packages depending on the level of access to potential car buyers --and data about those buyers -- they desire.

For example, a free account gets a dealer a basic listing so that their inventory appears on the CarGurus website, but a paid subscription includes features like Cargurus' pricing and market analysis tools. In 2019 and 2020, this segment accounted for 89% and 88% of total revenue respectively, helping contribute to overall gross margins above 90%.  

Shifting revenue into a new gear

In January of 2021, CarGurus acquired a 51% interest in CarOffers, a platform that allows automotive dealers to instantly buy and sell vehicles from each other, eliminating the traditional process of manual bidding and vehicle inspections. This acquisition had an immediate impact on the revenue mix for CarGurus. In Q1 2021, the percentage of non-subscription revenue (now called wholesale and other revenue) grew to 19%, which was attributable to the CarOffers acquisition and its wholesale vehicle sale revenue. This trend continued in Q2 and Q3 with wholesale and other revenue increasing to 34% and 35%, respectively.

This shift in revenue mix is important, because this segment is growing very rapidly. In the three quarters that have been reported in 2021, its year-over-year revenue growth has been 101%, 397%, and 347%. This is in addition to the subscription segment which grew 9%, 80%, and 11% over those same three quarters.

Investors need to check their blindspots

Despite the impressive revenue growth driven by the CarOffers acquisition, it's worth pointing out that the integration of this business has had an impact on the company's gross margins. In Q4 of 2020, the last reported quarter before the CarOffers acquisition, gross margin was 92%. That metric decreased to 73% in Q3 2021. Management attributed the decrease in gross margin to a 24% increase in cost of revenues for the CarOffers wholesale business. While that represents a substantial decrease in a relatively short time frame, investors will need to balance that against the increased revenue when making a decision about buying shares. 

Winning the investing race

It seems the market has noticed CarGurus' recent revenue growth. Year to date, the stock is up 18% compared to the S&P 500's 21% gain. In terms of valuation, CarGurus trades at a trailing price-to-earnings (P/E) ratio of 42. While that's not exactly cheap, it is down from its 2021 high of 63 and still below (CARS -1.52%), which has a trailing P/E ratio of 57.

Investors considering buying CarGurus stock should be encouraged at the increasing revenue growth but keep an eye on if in future quarters. If revenue can continue to grow at 50% or higher, the stock is inexpensive right now. If growth slows, the current valuation is less compelling. Regardless, management has made an acquisition that could prove to be a game-changer for CarGurus as an investment.