The stock market is a forward-looking creature and nothing illustrates this fact better than CarMax. The used car seller benefitted immensely from the pandemic-fueled vehicle demand surge. Sales in its fiscal year ending February, 2022, jumped an astonishing 68% to nearly $32 billion. The stock, however, had already peaked three months earlier. Apparently, the market was already looking ahead to the inevitable drop in demand. Between November, 2021, and December, 2022, CarMax lost two-thirds of its stock market value.
KMX fell 67% from an all-time high of $156 to as low as $52 a share in just thirteen months. At the current price of roughly $66, many are wondering if the stock has become a bargain. On a price-to-earnings basis, it might seem so, but our concerns lie elsewhere. Let’s begin with the Elliott Wave chart below.
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The daily chart of CarMax stock reveals that the decline from $156 to $52 is a five-wave impulse pattern. It is labeled 1-2-3-4-5 in wave (a), where the five sub-waves of wave 1 are also visible. Waves ‘v’ of 1 and ‘c’ of 2 are both ending diagonals. According to the theory, a three-wave correction follows every impulse before the trend can resume in the same direction.
That’s what we think is currently in progress in KMX stock. It looks like waves A and B of (b) are already in place. Wave C is likely to lift the stock up to the resistance area near $100 a share. Then, the 5-3 wave cycle would be complete and the bears should return. Downside targets for wave (c) lie near $40 or maybe even lower. But this bearish Elliott Wave setup is not the only thing CarMax investors should be worried about.
The Profitability of CarMax
It is true that 2022 delivered a record net income of $1.15B. Alas, it is also true that net income doesn’t reflect the true profitability of a business. Free cash flow does. It equals net income plus non-cash charges and working capital changes minus capital expenditures. FCF shows the amount of money a company really has at its disposal. And in the case of CarMax, it has been negative in four of the past five years, 2022 included.
In other words, despite record sales the company still lost money. To compensate for these losses, CarMax has been taking on more and more debt every year. As of end-November, 2022, it owes over $18B, up from $12B in 2018. Rising borrowings and operational losses often put companies on the fast track to chapter 11. Higher interest rates and a darkening economic outlook make CarMax all the more risky as an investment. When fundamentals and Elliott Wave analysis both say to stay aside, we stay aside.
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