This Used Car Dealer Had a Board Member Buy In

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According to a filing with the SEC, Rakesh Gangwal, who sits on the Board of Directors at CarMax (NYSE: KMX), purchased 30,000 shares of the company’s stock on February 7 at an average price of $39.43 per share. CarMax is a used car retailer operating in the United States with a market capitalization of just over $9 billion. Insider activity is one of the factors we track in order to help us develop investment strategies and analyze stocks, alongside (for example) investments by hedge funds (the most popular small cap stocks among hedge funds, as detailed in our August 2012 newsletter, produced an excess return of 18% between September and January (read more about our hedge fund strategies).

As part of our research on insider trading, we have found that stocks bought by insiders narrowly outperform the market (see our analysis of studies on insider trading). One driver of this effect is that insiders have to be particularly confident that the stock price will rise--and are not just buying shares for show--because the principles of diversification suggest that under normal conditions insiders should actually be trying to reduce their financial exposure to the company.

CarMax’s most recent fiscal quarter ended in November 2012, with revenue and earnings each up about 15% from the same quarter in the previous fiscal year. This was a considerably stronger performance than the company had delivered in the first half of the fiscal year, particularly in terms of net income. The stock price is up 34% in the last year. At its current price CarMax is valued at 22 times its trailing earnings, so the market has priced in some growth; if the company can continue growing its earnings at a high rate for several years than it may prove to offer “growth at a reasonable price,” but our guess is that it is at least fairly valued at this time. It should be noted that CarMax has a beta of 1.8, suggesting that its business is sensitive to broader economic conditions.

Tom Gayner’s portfolio at Markel Gayner Asset Management included 5.2 million shares of CarMax at the end of September, making the stock his largest holding according to the 13F (Find more of Gayner's favorite stocks and read our interview with Tom Gayner from earlier this year). First Pacific Advisors, which is managed by Robert Rodriguez and Stephen Romick, owned 1.7 million shares at the end of the third quarter, unchanged from three months earlier.

Other auto dealers include AutoNation (NYSE: AN), Penske Automotive (NYSE: PAG), Group 1 (NYSE: GPI), and Sonic Automotive (NYSE: SAH). These peers all trade at a discount to CarMax, with Penske and Group 1 trading at 16 times trailing earnings while the trailing P/E multiples of the other two companies are still below 20. All four of these comparable companies have posted double-digit revenue growth rates versus a year ago as well, though only in the case of AutoNation and Group 1 has that translated into a similarly strong improvement on the bottom line. AutoNation also stands out for carrying a beta just under 1, while the other companies are about as responsive to the market as CarMax. Overall, it seems that this peer group would be a richer source of value than CarMax. In addition, it’s possible that this insider purchase is occurring due to perceived strength in economic trends that would benefit auto dealers in general, rather than factors specific to the company.

With its peers generally cheaper in terms of their trailing earnings, and generally matching CarMax in terms of sales growth, we don’t think that it is a good buy either in absolute terms or compared to its industry. AutoNation and Group 1 in particular seem to have significant advantages at least upon first look and would be better places for an investor to begin their research.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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