Should CarMax, Inc.’s (NYSE:KMX) ROE Concern?

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One of the best investments we can make is our own knowledge and skill sets. With that in mind, this article discusses how to use Return on Equity (ROE) to better understand your business. To make the lessons hands-on, use ROE to better understand CarMax, Inc. (NYSE:KMX).

Return on equity or ROE is an important measure used to assess how efficiently a company’s management is using the company’s capital. More simply, it measures a company’s profitability in relation to shareholders’ equity.

Check out our latest analysis on CarMax.

How do you calculate return on equity?

ROE can be calculated by the following formula.

Return on Equity = Net Income (from Continuing Operations) ÷ Shareholders’ Equity

So, based on the above formula, CarMax’s ROE is:

8.6% = US$485 million ÷ US$5.6 billion (based on last 12 months to February 2023).

“Return” means annual profit. His one way of conceptualizing this is that for every $1 in stockholders’ equity, the company earned his $0.09 in profits.

Is CarMax’s ROE good?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. Importantly, even within the same industry classification, companies vary widely, so this is far from perfect. As shown in the chart below, CarMax’s ROE is lower than the specialty retail industry classification average (20%).

NYSE: KMX Return on Equity May 18, 2023

Unfortunately it’s not optimal. However, low ROE is not necessarily bad. If a company has moderate to low debt levels, there is still potential to improve earnings through the use of financial leverage. Companies with high debt levels and low ROEs are a combination to avoid when considering risk. To learn about the two risks we’ve identified for CarMax, visit our risk dashboard for free.

Importance of debt to improve return on equity

Businesses usually need to invest money to increase their profits. That cash may come from the issuance of equity, retained earnings, or debt. In his first two cases, ROE captures the use of capital for growth. In the latter case, using debt will improve your earnings, but your equity will remain the same. Thus, the use of debt improves his ROE even if the core economics of the business remain unchanged.

Combined with CarMax’s debt and return on equity of 8.6%

CarMax has a very high debt-to-equity ratio of 3.27, suggesting that it uses a large amount of debt to maximize earnings. If a company has a fairly high debt to equity but a fairly low ROE, it is considered a negative sign.

summary

Return on equity helps you compare the quality of different businesses. According to our book, top quality companies have higher return on equity despite having less debt. If two companies have about the same level of capital to debt and one has a higher ROE, I usually prefer the one with the higher ROE.

That said, while ROE is a useful indicator of the quality of your business, determining the right price to buy a stock requires consideration of many factors. Expectations reflected in earnings growth and stock prices are particularly important considerations. So it’s good to take a peek at the data-rich interactive charts that show the company’s forecasts.

But please note: CarMax may not be the best stock to buy.so take a look at this free List of interesting companies with high ROE and low debt.

Valuation is complicated, but we’re here to help make it simple.

Check out our comprehensive analysis, including the following, to see if CarMax is potentially overrated or underrated. Fair value estimates, risks and warnings, dividends, insider trading and financial health.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst projections using only unbiased methodologies and articles are not intended as financial advice. This is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. We aim to provide long-term focused analysis based on underlying data. Please note that our analysis may not take into account the latest announcements or qualitative material from price-sensitive companies. Simply Wall St does not have any positions in any of the securities mentioned.



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