CarMax, Inc.’s (NYSE:KMX) Investment Returns Are Lagging Its Industry

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Today we’ll evaluate CarMax, Inc. (NYSE:KMX) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for CarMax:

0.067 = US$1.1b ÷ (US$18b – US$1.2b) (Based on the trailing twelve months to November 2018.)

Therefore, CarMax has an ROCE of 6.7%.

Check out our latest analysis for CarMax

Does CarMax Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, CarMax’s ROCE appears meaningfully below the 13% average reported by the Specialty Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, CarMax’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

NYSE:KMX Last Perf February 7th 19
NYSE:KMX Last Perf February 7th 19

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CarMax.

What Are Current Liabilities, And How Do They Affect CarMax’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

CarMax has total assets of US$18b and current liabilities of US$1.2b. Therefore its current liabilities are equivalent to approximately 6.7% of its total assets. CarMax reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

The Bottom Line On CarMax’s ROCE

CarMax looks like an ok business, but on this analysis it is not at the top of our buy list. But note: CarMax may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.