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A look at education stocks over the past year provides a nice lesson in the benefits of value investing -- buying stocks that are cheap relative to cash flow and earnings and then holding them until they regain favor with investors.
In 1999, education stocks, except for a few "e-learning" dot-coms that debuted the same year, were decidedly out of favor. Most of the 15 education stocks Merrill Lynch covers were well into negative territory, while the Standard & Poor's 500-stock index was up 21%. Now look at 2000: So far this year, that same group of education stocks is up 50%, and the S&P is down 2%, says Merrill analyst Kathleen Bailey.
"What a change," says Greg Cappelli, an education analyst with Credit Suisse First Boston. He notes that DeVry, which lost about 40% of its market value in 1999 on concerns that enrollment growth was slowing, has seen its stock double this year, to $39 -- making its gains even greater than the group's.
A variety of factors have fueled the group's gains. Enrollment growth is strong, and earnings are exceeding estimates, thanks to a job market hungry for employees with technical and business skills. U.S. Bancorp Piper Jaffray reports that all 12 companies in its "learning services" group met or exceeded Wall Street's forecasts for their most recent quarters.
TOO PRICEY? Corporations are also bringing education in-house, spending more money and implementing new technologies to teach their employees. Plus, the Presidential race is putting education in the forefront, and candidates are promising to make more dollars available for financial aid. The Internet is also creating more opportunities for education companies. Gerald Odening, an analyst at Chase H&Q, believes that at the post-secondary level, online education will account for one-third of all coursework in five years, compared with less than 10% today.
But perhaps most important to the sector's gains is that the market has turned away from once-hot tech stocks in favor of companies with real cash flow and predictable earnings. These stocks also look especially good right now, notes Bailey, since they don't have foreign exchange or fuel-cost exposure. The total education market is $740 billion, with almost half -- $360 billion -- spent on kindergarten through grade 12. "[This is] a big market with great fundamentals," she says.
The one drawback: With many stocks now trading at price-earnings ratios higher than the market, it's hard to argue that education stocks are still cheap. DeVry is one that several analysts says is too expensive. At $39 a share and trading for 45 times next year's earnings, it's rated a "hold" by Cappelli. Apollo Group (
APOL
), which operates for-profit University of Phoenix, fell nearly 10% in mid-September after an analyst raised valuation concerns. "Six months ago you could just buy the group," says Cappelli. "Today you need to pick your stocks."
But analysts, who are almost always upbeat on their sectors, still have their favorites. Scott Wilson, who covers higher-education companies for Merrill Lynch, thinks Apollo still has room to run. Merrill is on the road now talking to investors about its upcoming public offering of shares in University of Phoenix Online, which Wilson believes will be "a great catalyst for the company." The virtual university has 14,000 students, and enrollment is increasing 40% a year, he says. His other favorites are Saba (
SABA
), which builds the infrastructure that corporations use to deliver and manage employee training, and SmartForce (
SMTF
), which offers information technology training over the Web.
A DESIRE FOR REFORM. Odening says he's still "pounding the mahogany" on DeVry, which he thinks will get a boost from its new online bachelor's degree, announced in August. His other favorite is Career Education (
CECO
), which offers classes primarily in graphic design, cooking, and IT. Even though it has run up from $15 in May to $39 and is now trading at 30 times next year's earnings, he thinks it can continue to rise. In the online-learning space, his picks are Digitalthink (
DTHK
) and Skillsoft (
SKIL
), both of which sell products to help companies deliver training to employees.
In the K-12 market, Bailey favors for-profit charter-school operator Edison Schools (
EDSN
). Athough it's still losing lots of money, Edison is positioned to take advantage of the public's desire for educational reform, and its revenue growth is strong. She also likes Advantage Learning Systems (
ALSI
), which has a huge installed base of computer-information systems already in schools, and day-care-center operator Bright Horizons Family Solutions (
BFAM
). It signs up big corporate sponsors (most recently Cisco Systems) to put up the capital, and then it builds and runs child-care centers on-site. "All three of these companies, by our price targets, have 20% appreciation in them," says Bailey.
While education stocks have had a good run already, it's important to remember that the sector was very depressed. Odening points out that current valuations are only what they were in 1998 -- well before the Internet pointed the way to faster growth. So, even if you missed the value play for education stocks, there may yet be an opportunity to invest in education's growth story this year.
Stone is an associate editor of Business Week Online Edited by Beth Belton
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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