After its shares rose an impressive 8% on strong earnings Wednesday, auto superstore CarMax (NYSE:KMX) shifted gears this morning; at last report, it's already given back half of those gains. Why is the stock shifting into reverse?
Wielding Occam's razor, my hunch is that the simplest answer is the correct one here: The stock price simply got ahead of the value of the company. With a trailing P/E ratio of 26, but long-term earnings growth projected at less than 18%, CarMax was simply looking too pricey by close of trading yesterday. But price aside, it's hard to argue that the company had anything but a fantastic quarter.
Sales grew 18% versus fiscal Q2 2006 on the back of a 7% rise in the number of used cars sold at "mature" stores, with new store openings contributing most of the balance of the increase. This led to a 44% rise in profits per diluted share, which at $0.50 surpassed Wall Street's best guess by a whopping 22%.
Now, there are a lot of things a Fool can say about CarMax's quarter, but I'm going to go down a road less traveled today and leave the parsing of the details to a Fool better versed in the nitty-gritty of this business. Philip Durell, lead analyst at Motley Fool Inside Value, will certainly review the company's performance in his next monthly roundup of developments at the Inside Value companies, leaving me free to focus on a couple of lines in the CEO's "business performance review" that might otherwise go unnoticed.
I quote: "We were particularly pleased with our robust sales performance given the difficult comparison with last year's second quarter when we reported 10% comps. Last year's quarter benefited from the domestic manufacturers' new car employee pricing programs, which drove traffic into the market and created greater pricing transparency."
Read that second sentence again, because I think it contains the key to CarMax's business model, its popularity with consumers, and its future success. Think back to the summer of 2005, when Ford (NYSE:F), GM (NYSE:GM), and DaimlerChrysler (NYSE:DCX) hit upon the novel idea of offering "employee pricing for everyone" (well, everyone but rivals Honda (NYSE:HMC), Nissan (NASDAQ:NSANY), and Toyota (NYSE:TM), who turned up their noses at the gambit). The Big Three's plan bore a simplicity that would have made William of Occam smile -- instead of the usual retail game of inflating prices, then offering "discounts" to convince buyers that they were getting a bargain, Detroit decided to set its prices low from the get-go, and see if a bit of transparency could drive sales. It worked.
What CarMax CEO Tom Folliard is saying, what CarMax has known for 13 years, and what Detroit learned last year, is this: Customers hate tricks. They love simple pricing. Simply put, when a good product is offered for a reasonable price, people will buy it. More importantly to CarMax investors, when automakers sell new cars for fixed prices without all the tricks, competing head-to-head with CarMax's quality used cars on price, customers tend to prefer CarMax's value proposition. That truth bodes well for CarMax's future chances of posting many more quarters like this last one.
Get great mileage with related Foolishness:
For an even more in-depth view of CarMax's business, read Philip Durell's detailed write-up on the company in Inside Value -- yours for the reading when you take a free trial of the service.
Fool contributor Rich Smith has no interest, short or long, in any company named above. The Fool's disclosure policy is going racin' in the street.
