With a price-to-earnings (or "P/E") ratio of 27.4x CarMax, Inc. (NYSE:KMX) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
CarMax has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
How Is CarMax's Growth Trending?
In order to justify its P/E ratio, CarMax would need to produce impressive growth in excess of the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 7.4%. This means it has also seen a slide in earnings over the longer-term as EPS is down 62% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Looking ahead now, EPS is anticipated to climb by 38% per year during the coming three years according to the analysts following the company. With the market only predicted to deliver 11% per year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that CarMax's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Bottom Line On CarMax's P/E
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that CarMax maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
Plus, you should also learn about this 1 warning sign we've spotted with CarMax.
Of course, you might also be able to find a better stock than CarMax. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
