It is less than nine years since Auto Trader (LSE: AUTO) listed on the stock market. Yet, in under a decade, the Auto Trader share price has increased 158%.
More than doubling in less than a decade is impressive. Could the same happen again?
Steady over time
First, I ought to explain why I think that performance is impressive.
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Some people imagine doubling their money in a few weeks or months. Over a period of close to a decade, shares like Tesla have returned increases of over 1,000% in certain periods. That is very uncommon, however, and in some periods Tesla shares have dropped a lot in value.
I invest for the long term. Over the long term, a lot of shares lose value, go nowhere, or gain only modestly.
Doubling in less than a decade therefore strikes me as good going.
Strong performance
The company released its interim results today (9 November). I think they underline why the long-term investment case for Auto Trader remains attractive.
Revenues grew 12% in the first half compared to the same period last year, while operating profits were up 10%. Cash generated from operations grew 12% to £184m. The interim dividend was raised 14%.
What lies behind this sort of strong performance? As the leading UK online marketplace for vehicles, Auto Trader benefits from what is known as network effects. The more buyers it attracts, the stronger its sales pitch to sellers. More sellers in turn attract buyers.
The volume of traders on the site is at record levels. I expect that to stay high thanks to network effects. In turn, that gives the company pricing power that helps to drive profits.
Long-term share price outlook
At the moment, the Auto Trader share price gives the company a price-to-earnings (P/E) ratio of 28. That looks expensive to me and reflects the enthusiasm of investors for this quality business.
Could the shares double in the coming decade, given their current valuation?
Looking back at the period from 2014 to this year, revenues have grown at a compound annual growth rate (CAGR) of 8.6%. That is already a strong performance in my view.
But here is the really interesting part. In that period, post-tax profits have shown a CAGR of over 40%. That is not a one-off thanks to an unusually good year, but reflects performance over almost a decade. I think that shows just how strong the pricing power of Auto Trader’s business model is. In the first half, its operating profit margin was almost 60%.
If profits continue to grow at that sort of rate, I think the Auto Trader share price could follow. On that basis, I could see it doubling in the coming decade.
Valuation leaves little room for error
However, that P/E ratio still looks high to me.
I think it presumes ongoing superb performance. If the company runs into a problem at some point, that could lead to a lower valuation. So, even if the business still performs well but not quite as well as hoped, I think the Auto Trader share price could fall.
The company expects “a modest decline in retailer numbers for the full year” compared to the first half.
If the used car market declines – for example due to a recession leading owners to trade up less often – that could hurt revenues and profits.
