Markets

Should You Buy CarMax Inc. (KMX) or Cars.com Inc. (CARS)?

CarMax Inc. (NYSE:KMX) and Cars.com Inc. (NYSE:CARS) are the two most active stocks in the Auto Dealerships industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.

Growth

The ability to grow earnings at a compound rate over time is a crucial determinant of investment value. Analysts expect KMX to grow earnings at a 12.16% annual rate over the next 5 years. Comparatively, CARS is expected to grow at a 15.00% annual rate. All else equal, CARS’s higher growth rate would imply a greater potential for capital appreciation.

Profitability and Returns



Just, if not more, important than the growth rate is the quality of that growth. Growth can actual be harmful to investors if it comes at the cost of weak profitability and low returns. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return. CarMax Inc. (KMX) has an EBITDA margin of 7.95%, compared to an EBITDA margin of 32.53% for Cars.com Inc. (CARS). This suggests that CARS underlying business is more profitable. KMX’s ROI is 4.10% while CARS has a ROI of 7.30%. The interpretation is that CARS’s business generates a higher return on investment than KMX’s.

Cash Flow 

The amount of free cash flow available to investors is ultimately what determines the value of a stock. KMX’s free cash flow (“FCF”) per share for the trailing twelve months was +0.60. Comparatively, CARS’s free cash flow per share was +0.55. On a percent-of-sales basis, KMX’s free cash flow was 0.69% while CARS converted INF% of its revenues into cash flow. This means that, for a given level of sales, KMX is able to generate more free cash flow for investors.




Liquidity and Financial Risk

Liquidity and leverage ratios provide insight into the financial health of a company, and allow investors to determine the likelihood that the company will be able to continue operating as a going concern. KMX has a current ratio of 2.30 compared to 1.50 for CARS. This means that KMX can more easily cover its most immediate liabilities over the next twelve months. KMX’s debt-to-equity ratio is 3.89 versus a D/E of 0.45 for CARS. KMX is therefore the more solvent of the two companies, and has lower financial risk.

Valuation

KMX trades at a forward P/E of 17.11, a P/B of 4.00, and a P/S of 0.78, compared to a forward P/E of 24.77, a P/B of 1.26, and a P/S of 3.02 for CARS. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

Analyst Price Targets and Opinions

When investing it’s crucial to distinguish between price and value. As Warren Buffet said, “price is what you pay, value is what you get”. KMX is currently priced at a -1.52% to its one-year price target of $69.13. Comparatively, CARS is 4.52% relative to its price target of $25.00. This suggests that KMX is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.40 for KMX and 2.00 for CARS, which implies that analysts are more bullish on the outlook for KMX.

Risk and Volatility

Beta is a metric that investors frequently use to analyze a stock’s systematic risk. A beta above 1 implies above average market volatility. Conversely, a stock with a beta below 1 is seen as less risky than the overall market. KMX has a beta of 1.36 and CARS’s beta is shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

Short interest is another tool that analysts use to gauge investor sentiment. It represents the percentage of a stock’s tradable shares that are being shorted. KMX has a short ratio of 12.22 compared to a short interest of 15.46 for CARS. This implies that the market is currently less bearish on the outlook for KMX.

Summary

CarMax Inc. (NYSE:KMX) beats Cars.com Inc. (NYSE:CARS) on a total of 7 of the 13 factors compared between the two stocks. KMX has higher cash flow per share, has a higher cash conversion rate and higher liquidity. In terms of valuation, KMX is the cheaper of the two stocks on an earnings and sales basis, KMX is more undervalued relative to its price target. Finally, KMX has better sentiment signals based on short interest.

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