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2 Overlooked Reasons for Investors to Love CarMax, Inc. Stock

By Daniel Miller - Sep 17, 2015 at 8:00AM

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The overall growth story for CarMax is widely understood, but here are 2 overlooked factors that could help fuel growth.

Most investors are optimistic about CarMax, Inc's (KMX 5.67%) future because of its historic growth rates. Consider that over the last decade, ending fiscal year 2015, CarMax has grown its revenues and earnings per share by annual averages of 10.5% and 19.5%, respectively. Those are impressive numbers for any decade, especially when it includes a severe financial crisis that sent sales of vehicles plunging.

Most investors also understand that CarMax's footprint only reaches 63% of the American population, and that the company plans to open as many as 48 stores by the end of fiscal year 2018 -- which is almost 32% growth from the end of fiscal year 2015.

It's clear the growth story is compelling -- but here are three overlooked reasons investors should love CarMax even more.

Network effect
When glancing over CarMax's business model from the 10,000-foot perspective, you wouldn't expect to find a network effect. After all, a network effect is typically seen with companies like LinkedIn or Facebook, which are more valuable to users as the total number of users increases.

While that's definitely a good example of a network effect, CarMax experiences a similar benefit. As CarMax continues to grow its number of stores significantly each year, its total number of vehicles in inventory will increase. CarMax's inventory of 60,000 used vehicles nationwide doesn't create a network effect on its own. However, CarMax's move to connect its nationwide inventory to its website, which enables customers to transfer nearly any used vehicle to a local store for purchase, certainly makes every new dealership that much more valuable in the grand scheme.

As CarMax grows its store count between 13 and 16 new stores annually over the next couple of years in cities such as Minneapolis and Boston, incremental sales as far away as Los Angeles could be generated -- and that's an effect investors should love.

Beyond its network effect, there's another hidden reason to be optimistic about CarMax's future growth.

CarMax Auto Finance
At the end of fiscal year 2015, sales of CarMax retail used vehicles generated 57% of gross profit dollars. For that reason, it makes sense that most investors overlooked the 13% generated by finance. However, there could be a good amount of upside in this business segment for CarMax and its investors.

Obviously, as CarMax continues to improve its comparable-store sales and overall total units sold, CAF stands to benefit -- just as it has already, as you can see below.

Chart source: CarMax, European Investor Presentation.

Where's the upside, you ask?

Consider that at the end of fiscal year 2015, CAF financed just over 40% of its retail vehicle unit sales. That doesn't mean CarMax wants to increase that significantly -- there are some consumers the used-vehicle retailer doesn't want to finance, as their loans would be riskier. However, there should definitely be some room to grow the percentage of loans it finances out of total retail units sold, and that would send CAF income higher faster than it has in the past.

Already, as of the first fiscal quarter of 2016, CAF has increased its managed receivables to $8.5 billion from $7.9 billion as posted in the above graph at the end of fiscal 2015.

Ultimately, investors are familiar with the major aspects of CarMax's growth story, but there are definitely some overlooked elements that could make owning CarMax even more lucrative as its story continues to develop long-term. 

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