Investors Still Waiting For A Pull Back In CarMax, Inc. (NYSE:KMX)

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider CarMax, Inc. (NYSE:KMX) as a stock to potentially avoid with its 23.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings that are retreating more than the market's of late, CarMax has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

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How Is CarMax's Growth Trending?

CarMax's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 13%. The last three years don't look nice either as the company has shrunk EPS by 32% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 41% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 12% each year, 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. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From CarMax's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for CarMax you should be aware of.

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.