Investor Essentials Daily

A beam of light in the automotive industry, this company does not get affected by lower sales volumes

October 11, 2022

The car industry has not been able to recover from the pandemic, and players in the industry are struggling with low car sales.

The market is punishing all of the companies related to it, but it fails to recognize that those innovating the industry still make a lot of money.

CarGurus (CARG) is one of them. With its online marketplaces, the company continued to improve its profitability massively in struggling times.

That’s why it showed up on our FA Alpha Screen. Its strong profitability, high growth potential, and low valuations make it an interesting name.

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It wasn’t easy to adapt to COVID-19 restrictions, and everyone is more than happy to go back to their pre-COVID lives.

As soon as the pandemic slowed down, we found ourselves outside in parks, at the office, and traveling. A lot of industries have recovered at the same pace, reaching and sometimes surpassing pre-COVID levels.

However, some industries were not that lucky. A big example of this is the automotive industry.

The number of vehicles sold dropped from 17 million in 2019 to 14.5 million in 2020, a whopping 15% decrease.

The market seemed a bit better in 2021, but 2022 was another hit for automotive manufacturers and dealers. Each month in the first half of the year saw lower sales compared to the same months in 2021.

Investors are worried about car sales and are punishing companies related to it. They do not realize that those innovating and revolutionizing the industry may be able to still make money.

CarGurus is a name that comes to mind when we think about innovating in the car industry. The company operates an online automotive marketplace connecting buyers and sellers of cars.

Investors do not understand the operations of the company and how profitable it can get. This is because they are looking at the distorted as-reported data, which fails to show CarGurus’ real performance.

The as-reported return on assets (“ROA”) of the business was only 7% in 2018 and surged to 13% in 2021.

If we clear up the numbers using Uniform Accounting and look at the real data, we see an incredibly different business.

Uniform ROA was much higher than what is suggested by as-reported accounting. It jumped from 17% in 2018 to a massive 53% in 2021.

It seems CarGurus’ ability to innovate proved effective in protecting it against lower sales. In a time when everyone in the industry struggled, its online marketplaces have been minting money.

Additionally, CarGurus is trading at a historical low of 3.4x Uniform P/E, showing that the market is not seeing this big potential yet.

The improving profitability, high growth potential, impressive returns, and a low Uniform P/E meant that CarGurus rose to the top to become an FA Alpha name.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies, but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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