Although the S&P 500 is down 1.2% over the past six months, CarMax’s stock price has fallen further to $70.45, losing shareholders 10.9% of their capital. This might have investors contemplating their next move.

Is there a buying opportunity in CarMax, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Despite the more favorable entry price, we're swiping left on CarMax for now. Here are three reasons why KMX doesn't excite us and a stock we'd rather own.

Why Is CarMax Not Exciting?

Known for its transparent, customer-centric approach and wide selection of vehicles, Carmax (NYSE:KMX) is the largest automotive retailer in the United States.

1. Shrinking Same-Store Sales Indicate Waning Demand

Same-store sales show the change in sales for a retailer's e-commerce platform and brick-and-mortar shops that have existed for at least a year. This is a key performance indicator because it measures organic growth.

CarMax’s demand has been shrinking over the last two years as its same-store sales have averaged 8.4% annual declines.

2. Low Gross Margin Reveals Weak Structural Profitability

At StockStory, we prefer high gross margin businesses because they indicate pricing power or differentiated products, giving the company a chance to generate higher operating profits.

CarMax has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 10.6% gross margin over the last two years. That means CarMax paid its suppliers a lot of money ($89.44 for every $100 in revenue) to run its business.

3. High Debt Levels Increase Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.

CarMax’s $19.22 billion of debt exceeds the $271.9 million of cash on its balance sheet. Furthermore, its 17× net-debt-to-EBITDA ratio (based on its EBITDA of $1.09 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. CarMax could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope CarMax can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

CarMax isn’t a terrible business, but it doesn’t pass our quality test. After the recent drawdown, the stock trades at 19.5× forward price-to-earnings (or $70.45 per share). This multiple tells us a lot of good news is priced in - we think there are better stocks to buy right now. We’d suggest looking at one of our top digital advertising picks.

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