Down 8%, are FTSE 100 investors overlooking Auto Trader?

The FTSE 100‘s awash with great investment opportunities. But they’re not always such brillian opportunities for the same reasons in each case.

Auto Trader (LSE:AUTO) doesn’t always come up on my radar because it isn’t clearly undervalued. In fact, none of the valuation metrics scream undervalued to me. It trades at 23 times forward earnings but is ‘only’ expected to deliver 12.5% and 10% earnings growth in 2025 and 2026.

This gives us a price-to-earnings-to-growth (PEG) ratio of 2.2. Those of you familiar with this ratio — calculated by dividing the forward price-to-earnings ratio (23) by the average expected earnings growth — will know that 2.2 is far above the benchmark for good value (1).

The dividend yield, sitting at 1.43%, also doesn’t excite me. And clearly any dividend-adjusted PEG ratio still wouldn’t come anywhere near that benchmark figure of ‘1′.

Quality comes at a premium

However, as investors will know, quality stocks come at a premium. And there are very few companies on the FTSE 100 that have such impressive margins and market positioning.

Auto Trader’s the UK’s number one marketplace for vehicles. In fact, its network effect is so strong that it generates around eight times more revenue than the second largest player in the industry.

This gives it great pricing power. Dealerships clearly aren’t happy at seeing prices increase year after year, but Auto Trader’s among the best at delivering value to its clientele.

This translates into a super-strong operating margin of 62.7% over the past 12 months. The company also boasts a 43% return on assets and a 65.1% return on common equity.

This is a sign of a quality company. And it’s also complemented by a rock-solid balance sheet. Auto Trader has a net cash position of £11.8m.

This isn’t an amount of cash to adjust the PEG ratio significantly, but it’s a sign of financial robustness. It provides flexibility for new acquisitions or programme developments — such as artificial intelligence (AI) discovery tools or consumer-to-business operations.

In short, this also means it’s one of the most financially stable companies on the FTSE 100. A net cash position, strong cash flows, recurring revenue, and a near-monopoly position in car sales, which looks fairly secure.

The bottom line

A few years ago, inventory-holding online dealers such as Cazoo were considered the big challengers to the online marketplace companies — namely Auto Trader being the largest incumbent by far.

However, that risk appears to have passed. Inventory-holding online dealers could soon become some of the biggest clients for marketplace companies.

That doesn’t mean there’s no risk. Trends in car buying are changing all the time. There’s been movement towards leasing rather than buying outright, and companies like leasing.com are better positioned for this shift.

There’s also AI. Super apps could transform this sector, transforming online marketplaces into little more than data repositories. It could also play into Auto Traders’ hands.

It’s a great company but the valuation’s a concern. I might be overlooking it, but I’m not sure it’s worth considering right now. It’s one for my watchlist.

The post Down 8%, are FTSE 100 investors overlooking Auto Trader? appeared first on The Motley Fool UK.

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James Fox has no position in any of the shares mentioned. The Motley Fool UK has recommended Auto Trader Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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