Earnings Tell The Story For CarMax, Inc. (NYSE:KMX)

With a price-to-earnings (or "P/E") ratio of 19.8x 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 17x 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.

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Recent earnings growth for CarMax has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for CarMax

If you'd like to see what analysts are forecasting going forward, you should check out our free report on CarMax.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, CarMax would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a decent 6.4% gain to the company's bottom line. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 54% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 19% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 10% per annum, which is noticeably less attractive.

With this information, we can see why CarMax is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

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. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with CarMax, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on CarMax, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.