What Every CarMax Investor Should Know Before Buying

CarMax (NYSE: KMX) is heading into its Dec. 18 earnings report facing the toughest backdrop in its 32-year history.

The stock has collapsed more than 50% year to date, slumping to a 13-year low after a brutal second-quarter miss on sales and earnings per share (EPS). It's now down 75% from its November 2021 all-time high -- one of the deepest multiyear slumps of any major specialty retailer.

With a market cap of $5.5 billion, CarMax is now the second-smallest of 44 stocks in the Consumer Discretionary Sector SPDR Fund (NYSEMKT: XLY), which tracks the consumer discretionary sector. That market segment has been among the worst performing sectors this year.

With CarMax currently operating under an interim CEO and interim executive chairman following the sudden removal of former CEO Bill Nash in September, its upcoming Q3 results will serve as a reboot for expectations and outlooks on how the country's largest used car retailer plans to regain traction and upward trajectory.

With that backdrop, investors need to keep two key forces in mind for the time being.

Image source: Getty Images.

1. Affordability

While used car prices have come down from record highs set in 2022, the average is still close to $26,000, a reality CarMax noted has seen customers shift toward older, higher-mileage vehicles. At the same time, interest rates have come down but are still elevated, with CarMax's finance arm reporting an average rate of 11.2% in Q2 -- a level that also pressures affordability, and in turn, wholesale buying and selling.

These macroeconomic pressures, along with tariff-related demand shifts earlier this year, were also highlighted in the specialty retailer's latest results -- mirroring similar stress reported throughout the sector.

In its favor, however, by almost any valuation metric, shares of CarMax have never been cheaper. According to Koyfin data, its trailing-12-month price-to-earnings (11.2), price-to-sales (0.2), and price-to-book (0.9) ratios have never been lower during the past 20 years.

2. CEO shake-up

The board's decision to remove its long-tenured CEO following the Q2 earnings release has only underscored the urgency of the situation. Interim CEO David McCreight and interim Executive Chair Tom Folliard are now tasked with stabilizing the business while also reassuring investors that CarMax's omnichannel model, online appraisal engine, and finance arm can adapt to changing consumer preferences and reaccelerate when affordability normalizes.

"The Board has decided that more direct involvement from David and me will help strengthen the business in this transitional period," Folliard said in the Nov. 6 statement, adding, "we are focused on driving sales, enhancing profitability and reducing cost."

Analysts are, unsurprisingly, cautious though not outright bearish, with 14 hold ratings and two buy ratings. Their average 12-month price target, however, has been halved from $81 in early September to $40 today, which implies about 7% upside from recent levels.

Conclusion

CarMax is now a deep-value turnaround story that's sitting at the intersection of a tough affordability cycle and a sudden leadership reset. But if pricing continues to normalize and interest rates trend lower, the stock's historically low valuation could set the stage for a rebound.

Until then, management needs to prove it can stabilize the company and deliver fresh catalysts to encourage investors to revisit its stock.

Matthew Nesto has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CarMax. The Motley Fool has a disclosure policy.