CarMax Inc. (KMX) has seen a significant price increase over the last few years, which will attract many speculative investors. However, Benjamin Graham, the father of value investing, taught that the sole factor in investment decisions as the most important aspect to consider is whether the company is trading at a discount relative to its intrinsic value. It’s through a thorough fundamental analysis that the investor is able to make a determination about a potential investment’s merits. Here’s an updated look at how the company fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company. By using theModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.
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Defensive Investor – Must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – Market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – Current ratio greater than 2 – PASS
- Earnings Stability – Positive earnings per share for at least 10 straight years – PASS
- Dividend Record – Has paid a dividend for at least 10 straight years – FAIL
- Earnings Growth – Earnings per share has increased by at least 1/3 over the last 10 years using 3-year averages at beginning and end of period – PASS
- Moderate PEmg (price over normalized earnings) ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – Must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – Current ratio greater than 1.5 – PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt-to-Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – Positive earnings per share for at least 5 years – PASS
- Dividend Record – Currently pays a dividend – FAIL
- Earnings growth – EPSmg greater than 5 years ago – PASS
|MG Opinion||Fairly Valued|
|Value Based on 3% Growth||$32.03|
|Value Based on 0% Growth||$18.77|
|Market Implied Growth Rate||12.53%|
|Net Current Asset Value (NCAV)||-$34.96|
Balance Sheet – February 2015
Earnings Per Share
Earnings Per Share – ModernGraham
CarMax does not pay a dividend.
CarMax Inc. does not qualify for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the lack of dividends, and the high PEmg and PB ratios. The Enterprising Investor takes issue with the level of debt relative to the net current assets as well as the lack of dividends. As a result, any purchase of the company is made with a speculative nature behind it. That said, any speculator interested in pursuing the company should still proceed to the next part of the analysis, which is a determination of the company’s intrinsic value.
With regard to the intrinsic value, the company has grown its EPSmg (normalized earnings) from $1.11 in 2011 to $2.21 for 2015. This level of demonstrated growth supports the market’s implied estimate for earnings growth of 12.53% annually over the next 7-10 years. The ModernGraham valuation model therefore returns an estimate of intrinsic value within a margin of safety relative to the current price, indicating the company is fairly valued at the present time.