Used Car Retailers Could Be In For A Bumpy Ride

After a recent report in which Morgan Stanley analysts predicted that used car prices would endure an unprecedented decline in the coming years, the share prices of some used car merchants may soon be under pressure.

According to the report, the price of fill-sized used cars has declined year-over-year (YOY) for 39 consecutive months, and the YOY price decline in November for full sized cars was more than 20 percent. Analysts expect a similar trend in the future for other vehicle segments as well.

Savvy investors looking for a way to capitalize on this prediction might consider shorting the stocks of used car merchants themselves.

Stock Watch: CarMax

The stock of used car retailer CarMax, Inc. KMX is trading near all-time highs, and the company has been able to grow its earnings per share (EPS) by an average of over 50 percent annually the past five years.

However, with a price to earnings ratio (P/E) of over 24, the stock isn’t particularly cheap at these levels. Perhaps most troubling of all in light of a potential price slump is Carmax’s long-term debt to equity ratio of 2.4.

Stock Watch: America's Car-Mart

Another stock with potential exposure to falling used car prices is America’s Car-Mart, Inc. CRMT. With the stock up 20 percent year-to-date, Amerca’s Car-Mart currently sports a P/E over 20, its highest in over five years. While debt is certainly not an issue for the company, a price to earnings to growth ratio (PEG) of 2.4 suggests the stock could already be overpriced at these levels based on its projected growth rate.

Only time will tell if Morgan Stanley’s prediction of a collapse in used car prices is coming and how these retailers will weather the potential storm.