AutoNation has followed the market’s trajectory closely, rising in tandem with the S&P 500 over the past six months. The stock has climbed by 11.7% to $215.82 per share while the index has gained 9.5%.
Is now the time to buy AutoNation, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think AutoNation Will Underperform?
We're swiping left on AutoNation for now. Here are three reasons why AN doesn't excite us and a stock we'd rather own.
1. Shrinking Same-Store Sales Indicate Waning Demand
Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).
AutoNation’s demand has been shrinking over the last two years as its same-store sales have averaged 2.8% annual declines.
2. Low Gross Margin Reveals Weak Structural Profitability
We prefer higher gross margins because they not only make it easier to generate more operating profits but also indicate product differentiation, negotiating leverage, and pricing power.
AutoNation has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 17.9% gross margin over the last two years. Said differently, AutoNation had to pay a chunky $82.05 to its suppliers for every $100 in revenue. 
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
AutoNation burned through $178.2 million of cash over the last year, and its $9.75 billion of debt exceeds the $97.6 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the AutoNation’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of AutoNation until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
AutoNation falls short of our quality standards. That said, the stock currently trades at 10.4× forward P/E (or $215.82 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are superior stocks to buy right now. Let us point you toward one of our top digital advertising picks.
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