Buy when others are fearful: Keep an eye on CarMax KMX

I've outlined the bull call on this business earlier (do a search).

After two poorly performing sequential quarters mostly caused by margin squeeze in the entire industry, KMX has increased its market share and remained profitable (albeit 55% down yoy) in a dreadful economic environment. Consumers are looking to purchase more fuel efficient newer vehicles rather than older used gas guzzlers. If the economy worsens further, they may find that all they can afford are the older cars at any rate.

KMX has traded at a premium multiple to its competitors for a number of years i.e. twice the P/E ratio of Ashbury mostly due to its unique and difficult to reproduce business plan. It is growing organically, even now. It is a favourite of many value gurus and has been bought and held by Dodge & Cox, Warren Buffett (who owns 10% of the company) and Chris Davis (holding 15%). Davis, Buffett and D&C tend to batten down the hatches and hold on when they invest in these companies so I expect that will help put a intermediate term bottom in the share price. Not much insider buying or selling going on so this is an indeterminate indicator-- we should watch for this over the next few months.

The Achilles heel of both used and new vehicle dealers during capital market tightening periods, is the financing division. KMX has been pretty conservative about financing its vehicle sales in the past;however, a large amount of car loans remained on the books in Q1. Fortunately for KMX, Moody's and S&P both signed off on their car loans securitization move and they were able to sell off the debt and shore up the companies liquidity. This will allow them to continue to open new stores as per their strategy while the competition hunkers down.

Caveat: I expect short term weakness in the share price that could make investors stomachs collectively turn. I think that any shares less than $15 are cheap and it's definitely possible that the shares will get considerably cheaper than this. I would be surprised if the industry turns around before 2009 and as the dividend yield is 0, there are more conservative places to put your money right now.

I've put in a small limit order at $15 to add to an original position. I plan to watch the insiders activities carefully. History has shown that when they start buying (particularly the CFO and the more junior officers who have a bit less money to put at risk as opposed to the CEO), the bottom is here or near.

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