CarMax: Riding the Used Car Wave While Navigating Economic Crosscurrents

CarMax (KMX), the nation's largest retailer of used vehicles, has emerged as a standout player in an industry still grappling with post-pandemic volatility. With Q1 2026 results showcasing robust margin expansion and digital dominance, the company is capitalizing on near-term momentum. Yet, as interest rates linger near historic highs and economic uncertainty looms, CarMax's ability to balance growth with risk management will define its long-term success.

Near-Term Momentum: Margins Roar, Efficiency Soars

CarMax's Q1 performance underscores its strategic execution. Total gross profit jumped 12.8% to $893.6 million, driven by a record $2,407 gross profit per used vehicle—a $60 per-unit improvement year-over-year. This reflects not only pricing power but also operational rigor: SG&A expenses fell 680 basis points to 73.8% of gross profit, a clear win for cost discipline.

The company's digital playbook is a key driver. 80% of retail sales now originate from digital channels, reducing costs and boosting scalability. Meanwhile, AI integration into inventory management and pricing promises further efficiency gains. Even in weaker segments, like wholesale (which dipped 0.4% due to pricing pressures), margins remain robust at $1,047 per unit—a testament to CarMax's pricing muscle.

While KMX's stock has lagged the broader market in recent quarters, the Q1 results could mark a turning point.

Strategic Positioning: Betting on Digital and Financial Leverage

CarMax is not merely coasting on current trends—it's doubling down on long-term advantages. Its CarMax Auto Finance (CAF) division, though temporarily strained by a $20.5 million increase in loan loss provisions, is pursuing a $632 million securitization program to offload risk and expand lending. Management aims to boost CAF penetration to 50% of retail sales (from 41.8%) by 2026, leveraging its AI-driven credit models to target underserved markets.

The company's omni-channel dominance is another pillar. By funneling 80% of sales through its app and website, CarMax reduces transaction costs and builds customer stickiness. This model is scalable: even as used car sales moderate from pandemic peaks, digital efficiency ensures margins stay resilient.

Long-Term Risks: Interest Rates, Credit Quality, and Wholesale Headwinds

Yet, clouds linger on the horizon. Rising interest rates are a double-edged sword: while they boost CAF's net interest margin (now 6.5%), they also deter buyers from financing purchases. CAF's penetration has already dropped to 41.8%, and further declines could crimp profit growth.

Wholesale gross profit, though strong at $1,047 per unit, faces supply chain and pricing headwinds. A 1.7% dip in average wholesale prices hints at a slowing secondary market, which could strain margins if demand softens.

Perhaps the largest risk is credit quality. The 2022–2023 loan vintages, now showing elevated defaults, may foreshadow bigger problems if unemployment rises. CarMax's loan portfolio, while diversified, is not immune to an economic downturn.

While margins have trended upward, the coming quarters will test whether this expansion can outpace macroeconomic headwinds.

Investment Thesis: Buy with a Buffer

CarMax's Q1 results justify optimism, but investors must remain vigilant. The stock trades at 14x trailing earnings, a 20% discount to its five-year average, suggesting room for upside if margins hold. Management's aggressive buybacks ($199.8 million in Q1) and a 1.2% dividend yield add further value.

Recommendation: Buy KMX for a long-term portfolio, but set a stop-loss at $55 (15% below current levels) to protect against a severe economic slowdown. Focus on the $70–$80 price target, achievable if CAF penetration reaches 50% and gross margins stabilize above 22%.

Backtest the performance of CarMax (KMX) when 'buy condition' is triggered by positive quarterly earnings surprises, and 'hold for 30 trading days' after the announcement, from 2020 to 2025.
Historical data reinforces the need for caution. A backtest of a strategy buying KMX after positive earnings surprises and holding for 30 days from 2020–2025 resulted in a -33.58% return, with a maximum drawdown of -61.72%. This underscores the importance of risk management—such as stop-losses—given the stock's volatility during earnings-driven trades.

Conclusion: A Steady Hand in a Volatile Market

CarMax's Q1 results prove it can thrive in choppy waters—its margins are widening, its digital moat is deepening, and its balance sheet is flexible. Yet, the company's fate remains tied to macroeconomic forces beyond its control. For investors willing to accept this risk, KMX offers a compelling blend of growth and stability. The question is: Can CarMax's near-term momentum outpace the storm clouds on the horizon? The answer may well decide its next chapter.