On Friday morning, dread news emerged for CarMax (NYSE:KMX) investors: Goldman Sachs (NYSE:GS) hates the stock. Arguing that the stock's "premium multiple" portends a period of "relative underperformance" for the stock, and warning that last year's appreciation in the prices of used cars will not repeat in 2010, Goldman downgraded CarMax to "sell" today. But was that the right call?
I'm not so sure.
Buy the numbers
Viewed from one perspective, Goldman's got a good point. Relative to car-dealing rivals like AutoNation (NYSE:AN) or America's Car-Mart (NASDAQ:CRMT), CarMax's 20-times multiple to earnings does look a mite pricey. Or stack CarMax up against big names elsewhere in the retail segment – Wal-Mart Stores (NYSE:WMT), Target (NYSE:TGT), Best Buy (NYSE:BBY) -- they all sport lower P/E ratios than the used car-meister.
But on the other hand, Goldman itself admits that "growth potential is high," and indeed, if you survey the estimates that Wall Street publishes on these stocks, CarMax sports the highest expectations for five-year growth of any of these retailers -- car dealers or otherwise.
Growth at any price?
According to Goldman, these growth prospects actually form one of CarMax's Achilles' heels. Says the analyst, growth will require CarMax to make additional "investment that could prove dilutive in the short run." Seeing as it was only last year that CarMax finally made some free cash flow after years of negative free cash, an immediate reversion to cash-devouring store buildouts would be disappointing to free-cash-flow hounds.
And yet, I'm not entirely certain that CarMax does need to throw a lot of money at capital spending to get its growth engine gunning. To the contrary, just this morning, CarMax announced it's hiring 600 new employees to restaff stores that were drained of manpower during the downturn. To me, this suggests there's a lot of underutilized floor space at CarMax's existing stores, and plenty of potential for CarMax to grow sales -- and profit -- simply by maximizing the potential of its existing store base.
Foolish takeaway
Investors often give Goldman's pronouncements more weight than they're worth. But there's a reason this banker is currently ranked among the very worst analysts we track on Motley Fool CAPS. Sometimes, Goldman gets it wrong.
And today is one of those days.
