Core Concepts: Gear Up With Auto Retailers

More CEOs of stable, underleveraged companies should consider the debt-for-equity swap strategy. The math is elementary. Most CEOs think of deploying cash to dividends, capital expenditures and minor stock buybacks. When they think of hitting investment "home runs," they think of something complicated, such as a major acquisition. They don't consider something as simple as shrinking their share base by one-half.

By the way, while AutoZone is reasonably valued at about $131 per share, my analysis of indicates that rival AutoNation is undervalued at its current level of about $22. Its operating model has significant margin leverage yet to be unleashed. With continued share shrinkage, mid-single-digit sales growth and net profit margins that can increase by 35% to 50%, the ingredients are here for a quote that will double or more over the next three to five years.

Pedal to the Metal

An exceedingly rare investment opportunity exists now in CarMax. My thesis is unchanged since I originally wrote and spoke about the company in 2005; that is, buying CarMax stock today is akin to buying Home Depot (HD Quote) in the early '80s. This is what a 10-bagger opportunity looks like in the early days.

It's difficult to find companies that have 10 to 15 years of 20% annual growth in front of them, that completely dominate their category, and where growth is organic, not by acquisition. My guess is that fewer than 10 companies meet these criteria.

To understand the CarMax opportunity, you have to understand the model. This is not simply a retailer of used cars. CarMax is a paradigm shift. It is changing the way consumers buy and sell used cars.

Everybody is familiar with how the typical used-car dealer does business. Buyers pay more or less depending on their level of sophistication (i.e., Grandma gets hosed). Dealers maximize profit by low-balling offers for trade-ins, by selling warrantees, by manipulating finance terms and by extending endless offers and counteroffers while you wait, wait, wait.