We've been asking ourselves recently if the market has placed a fair valuation on CarMax Inc. Let's dive into some of the fundamental values of this large-cap Consumer Cyclical company to determine if there might be an opportunity here for value-minded investors.
CarMax, Inc., together with its subsidiaries, operates as a retailer of used vehicles in the United States. The company belongs to the Consumer Cyclical sector, which has an average price to earnings (P/E) ratio of 24.11 and an average price to book (P/B) ratio of 3.11. In contrast, CarMax Inc has a trailing 12 month P/E ratio of 18.5 and a P/B ratio of 1.9.
P/B ratios are calculated by dividing the company's market value by its book value. The book value refers to all of the company's tangible assets minus its liabilities -- meaning that intangibles such as intellectual property, brand name, and good will are not taken into account. Traditionally, a P/B ratio of around 1 shows that a company is fairly valued, but owing to consistently higher valuations in the modern era, investors generally compare against sector averages.
P/E ratios have their limits on their usefulness too. Since the P/E ratio is the share price divided by earnings per share, the ratio is determined partially by market sentiment on the stock. Sometimes a negative sentiment translates to a lower market price and therefore a lower P/E ratio -- and there might be good reasons for this negative sentiment.
One of the main reasons not to blindly invest in a company with a low P/E ratio is that it might have low growth expectations. Low growth correlates with low stock performance, so it's useful to factor growth into the valuation process. One of the easiest ways to do this is to divide the company's P/E ratio by its expected growth rate, which results in the price to earnings growth, or PEG ratio.
CarMax Inc's PEG ratio is 3.6, which shows that the stock is overvalued in terms of its estimated growth. For reference, a PEG ratio near or below 1 is a potential signal that a company is undervalued.