While thumbing through an old copy of “Beating the Street” recently, I came across a basic but powerful concept that applies just as much now as it did when legendary investor Peter Lynch wrote the book in 1993.#-ad_banner-#

Basically, Lynch reminds readers that just because a stock is already a huge multi-bagger doesn’t necessarily mean its high-flying days are over. After I read that, one particular stock came to mind.

Like most stocks, the one I’m thinking of took a major beating during the financial crisis. It sank to about $7 per share in October 2008 after trading between $11 and $18 during the prior 12 months. But in 2009, it rebounded like a champ, posting a 94% gain to finish the year just over $19. Since the darkest days of 2008, the stock is up 650% and now trades near $49 a share.

After such a steep run-up, shareholders in this company, AutoNation (NYSE: AN), may be wondering if now is a good time to sell. After all, how much higher can the stock go after a sevenfold rise in five years?

Quite a bit higher, in my opinion. I think the stock still has almost 90% upside, so selling now could be a big mistake.

A major factor in future returns will be AutoNation’s position as the leader in the retail auto industry. The company sells 33 vehicle brands at 267 dealerships in 15 states and has $17.2 billion in annual revenue. Its closest competitor, CarMax (NYSE: KMX), lags noticeably in size and sales, currently generating annual revenue of $12.3 billion at 120 locations.

	YouTube/AutoNation
	AutoNation sells 33 vehicle brands at 267 dealerships in 15 states and has $17.2 billion in annual revenue.

A more extensive dealer network has enhanced sales by making it easier for AutoNation to shift vehicles between dealers so customers can get the car or truck they want. This advantage has much to do with AutoNation’s superior revenue growth, which averaged almost 14% per year during the past three years, compared with 11.8% for the industry overall.

Because it’s bigger, AutoNation also consistently enjoys economies of scale and can usually keep costs substantially lower than competitors. At about 68%, for example, its sales, general and administrative (SG&A) expenses are often several percentage points below the industry mean.

Significantly better sales and lower costs have resulted in industry-leading profit growth. During the past three years, the company’s net income is up an average of almost 17% annually versus 15.6% for the industry as a whole.

Revenue appears set for more brisk growth. Last month, AutoNation posted a 6% year-over-year increase in sales, compared with just a 1% increase for the industry. Currently, new vehicle sales make up 57% of total revenue and should remain the company’s top revenue source for some time.

That shouldn’t be an issue in the short to intermediate term since new vehicle sales have been healthy, rising 11% in 2013. However, profits are harder to come by with new vehicles — which account for just one-quarter of AutoNation’s gross profit despite being such a large proportion of sales — so the company will need to pursue higher-margin activities to remain ahead of the competition.

Management knows this and has begun to expand AutoNation’s used vehicle and parts/service segments, which carry substantially better margins. For example, parts and service generates only 12% of revenue but accounts for 41% of gross profit. 

The company also recently undertook comprehensive rebranding, converting all 15 of its regional brands to the AutoNation brand to facilitate marketing and ensure consistent results from online searches.

Acquisitions have played (and will likely continue to play) a key role in future growth. For instance, AutoNation purchased a Chicago-area Honda and Hyundai dealership last year with annual revenue of $67.5 million. Also in 2013, the company acquired a number of Honda, Hyundai and Toyota dealerships in Phoenix and Dallas with combined annual revenue of about $250 million.

I estimate earnings per share (EPS) will climb about 14% a year from a current level of $2.83 to $5.50 in early 2019. I also believe the stock’s price-to-earnings (P/E) ratio will remain around its current level of about 17, which implies a price increase of 87% to $93.50 in that time.

Risks to Consider: AutoNation operates in a highly cyclical industry, so revenue can vary widely with overall economic conditions. Plus, nearly half of total revenue comes from California and Florida, so overexposure to those states is a concern, especially given that those states tend to fare worse than average in recessions. However, AutoNation is addressing the issue by focusing expansion efforts on other states.

Action to Take –> If you’re a shareholder in AN, I’d hang on to this stock even if you’re sitting on the full 650% gain. If you’re not a shareholder but are thinking of buying, now is a good time. With a forward P/E of 15 based on projected 2014 earnings, AN is an excellent value.

P.S. Investing doesn’t have to be complicated. If you invest in simple businesses that dominate their industries, you stand to make a killing in the market over time. It works. In fact, the stocks in our latest report, “The Top 10 Stocks For 2014,” have delivered a total return of 237% over the past five years following this simple strategy. To learn more about our top picks for this year –including several names and ticker symbols — click here.