Should You Invest in Used Cars?

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So, I just bought myself a car. Note that I don't say that I bought myself a NEW car, but just a car. It's a Chevy Impala with all the bells and whistles and, like a lot of guys with new cars, I'm very pleased with it. It's got a lot of bells and whistles that my old one didn't. Heck, I'm still figuring out what all of the buttons on the console do. It comes with everything.

What it also comes with is a previous owner. I bought it used. I know the old trope is still out there that buying a used car is a terrible risk, and the image of the slimy used car salesman trying to steer an unsuspecting buyer is a persistent one. In my experience, however, it doesn't really apply anymore. At least it doesn't if the buyer (me, in this instance) is doing things the right way. There's no longer any reason to buy a used car that's anything other than reliable and backed by a solid guarantee.

Yes, I could have gone to some seedy roadside used car place. But I didn't. I went to a Carmax (NYSE: KMX) dealership here in South Carolina and got to test drive several models at my own pace and without pressure. It was, overall, a positive experience. Just like the way I've bought several cars from various used car dealerships in the past. That's what got me thinking about the way the industry has grown and changed over the years.

Carmax

Carmax is probably the most visible sign of the change in the used car business over the years. A buyer can look online, decide on a model and options and arrange to look at cars at his or her convenience. Carmax even makes it easy to trade in one's old car if necessary. The firm has a good business model and a better way of handling customers.

In terms of investing, I think Carmax is a good buy. The firm's stock has grown more than 50% since last June, and insiders have been buying it back for themselves. I wish it paid a dividend, like I always do, but I think the growth will offset that. The P/E of 21.01 indicates to me that others think there's still some growth inside Carmax.

America's Car-Mart (NASDAQ: CRMT)

A bit different, America's Car-Mart has a larger focus on older used vehicles. It also makes a significant amount of its profit through financing the cars it sells. I like the way the entire arrangement is integrated. That's not unique to CRMT, of course. However, it's a positive sign whenever a business has the sense to try to control all aspects of a transaction.

The company posted a profit recently that beat expectations, and shares have jumped on the news. With a P/E below 15, that might indicate that the value is slipping away for a new investor for a while. Combine that with a wild ride for the firm's shares over the last year, which has left the stock flat for the last 12 months, and I'd be cautious in investing for anything but the five year+ time frame.

Group 1 Automotive (NYSE: GPI)

Group 1 operates dealerships in both the US and the UK. While not primarily a used car dealer, the firm does provide a soup-to-nuts solution for buyers of both new and used cars. Through Group 1 a buyer can get a car, finance it and insure it should they desire. Again, it's a good sign of a well organized firm to be able to offer every possible angle for a customer if they can.

The stock has, in the last week or so, taken a tumble of more than 10% on missed estimates. However, I think that's just an earnings season stumble. This is a stock I think will do well over the long haul. It did do some retrenching during the recession but reestablished it's growth and is going on an acquisition run beginning in 2011. It's up more than 850% since the bottom of 2008. It even pays about a 1% dividend yield. My recommendation is to get some if you can afford it.

Lithia Motors (NYSE: LAD)

Another seller of both new and used cars, Lithia is primarily located in the American West and Midwest. This is another smaller firm – its market cap is only a bit over $1 billion – that has been in an acquisition mode. Just in the last year it's added several dealers under its umbrella and is likely going to try to continue that.

The stock is a true winner in my book. It's grown 72% year-over-year, has a P/E above 15 and pays a 0.99% dividend. It's even raised its dividend 40% during the last year. There's very little here not to like and if you can afford it, I'd take a shot at getting some Lithia if you can.

Used cars sales are always going to be a bit counter-cyclical. We all should know that. The recent economic unpleasantness forced people away from the big, shiny new cars and towards used cars. But I think that might have taught some lessons that will affect long-term buying trends. Why should I have paid $25,000 for my new (used) car when I could get substantially the same vehicle for $11,000 like I did. If enough people out there made the breakthrough that used cars don't have to be terrible then there's a real industry here that's just ripe for a thoughtful investor.

Good luck!

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