Why I’m about to buy this FTSE 100 stock

Oliver Rodzianko breaks down why he’ll be buying FTSE 100 stock Auto Trader in the coming day. He admits the strengths far outweigh the risks.

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The FTSE 100’s Auto Trader (LSE:AUTO) is like Tinder for car lovers. Believe it or not, it began in 1977 as a print magazine. In 2013 it fully transitioned to online format.

The website doesn’t only trade cars, though. It also lists bikes, vans and caravans.

What I particularly like about Auto Trader is how user-friendly it is. Just like Amazon and Facebook make virtual shopping and socialising seamless, Auto Trader does this for car dealing.

Why I’d buy the company now

If I love a company but the financials don’t add up, there’s no way I can afford to buy it. With the current inflation environment in the UK and the cost-of-living crisis, it’s a necessity that I find financially secure companies that are going to keep on growing.

I’ve seen evidence that Auto Trader is one of the companies I can trust to keep delivering strong financials. However, there are risks, and Auto Trader’s include a less-than-best valuation and a lot of debt.

But I’d buy the company now because the share price is down 8% since its recent high. Also, with a price-to-earnings ratio of 28, I’d say the company is still moderately undervalued when considering its earnings growth and powerful margins.

A tech company centred around cars

From reading the 2023 annual report and carefully considering Auto Trader’s strategy and operational advantages, I can see a heavy focus on its platform and data over all else. I believe this is the right strategy.

Instagram can’t function without people, but the top-class product that keeps everyone connected is its app. Auto Trader is no different.

The company is also beginning to take this to the next level through AI integration including assistance in car buying and selling, data analytics and video advertisement creation through Phyron AI. I see the fact that Auto Trader is actively using AI as an essential step towards maintaining market dominance in the UK.

On that note, Auto Trader’s dominance is relatively confined to Britain. In the United States, Auto Trader faces competition from the likes of Autotrader (a different company), Cars.com and TrueCar. That could mean there’s a lack of long-term growth prospects for Auto Trader with an already saturated home market and a highly competitive overseas market.

Financials: risks and rewards

I’m well aware of the risks when investing in Auto Trader. The most notable of these is a lot of debt on the balance sheet and minimal cash.

However, over the long term, the debt profile of the company has massively improved. In 2012 the company had £1.2m in debt and £50m in cash. Today it has £70m in debt and £17m in cash.

To me, the strongest suit of the company is the margins. An operating margin of 55% is in the top 4% of 590 companies in the interactive media business.

If the company can continue getting people to swipe right on cars in the UK, AI integration might see those margins go up even more.

The bottom line

Putting Auto Trader in my portfolio is a no-brainer, and I will have bought shares by the end of the month. The company is the UK’s top app for car buyers and should continue to dominate. My main concerns relate to potential market saturation and revenue slowdown, but even then, AI initiatives could take the company further still.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Oliver Rodzianko has positions in Amazon. The Motley Fool UK has recommended Amazon and 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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