For-profit education stocks are setting up for a dramatic rebound as major fundamental factors shift in favor of these investments.
The for-profit education sector represents a tremendous value due to a confluence of regulatory issues and economic distress, which has caused these stocks to trade down to attractive valuations. At the same time, the broad challenges facing these stocks are beginning to lift, and investors are once again beginning to allocate capital back to the sector.
Education stocks have already begun to rebound over the past few weeks, but they are still trading at relatively low multiples (considering their growth potential).
I have three education stocks that you should consider adding to your portfolio right now. But first, let’s take a look at why these stocks are trading at a discount, and why investors can expect the group to rebound.
The broad challenges for education stocks
At the beginning of the financial crisis in 2007 / 2008, investors flocked to the for-profit education sector because it represented a “safe haven” when other stocks were trading sharply lower.
The rationale? With the economy in turmoil, unemployed workers would go back to school to earn better degrees and find new employment. The Federal government was expected to keep its liberal student loan policies as a sort of “stimulus program,” helping the unemployed develop new skills.
But as the economic crisis wore on, it became clear that education was not the problem. Students were graduating with degrees, but were not finding jobs in their area of study. Student loan default rates skyrocketed and the government realized that it had a problem on its hands.
In addition to the challenging employment environment, it appeared that a number of for-profit education companies were doing a poor job of actually educating their students. A few well-publicized studies showed that students enrolled in for-profit schools had lower graduation rates, lower employment levels, and higher loan default rates than their peers at not-for-profit schools.
The entire for-profit education sector was painted with the same brush and investigations were opened. The Fed instituted new enrollment policies and targets for graduation, employment, and loan payments for the students of for-profit education companies.
As a result of these new regulations, enrollment dropped at most of the for-profit schools, and by extension, profitability also dropped. This caused investors to flee the area as profit declined and levels of uncertainty increased.
The industry has seen a rotation of its investor base as growth stock investors and dividend investors have bailed out and looked for other opportunities.
Strayer Education Inc. (NASDAQ:STRA) is a good example of this. The company paid a $4.00 per share annually in dividends until the end of 2012, when it suspended its dividend program. The stock traded sharply lower when it announced the dividend suspension as high-yield investors liquidated their position and looked for other opportunities.
The stocks have had to drop significantly before they began to attract the attention of value investors. Today, a few of these names represent attractive valuations and we are finally starting to see capital rotate back into the area.
Making a case for a rebound
With education stocks trading at historic lows, and the broad economy beginning to improve, the investment profile for this sector is starting to look much more attractive.
There are two primary issues that should act as bullish catalysts to send these stocks higher.
1) Improving Employment: The unemployment rate is still higher than it was before the financial crisis, but has been steadily dropping. For the month of April, the national unemployment rate hit 7.5 which was below expectations, and economists believe that May was a strong month for hiring as well.
As employment rates rise, the case for higher education becomes stronger. Prospective students believe that they will have a shot at getting hired after school and become more willing to make the financial and time commitment of pursuing a bachelor degree or masters degree.
With the broad economy gradually mending, enrollment rates should begin to recover over the next several quarters.
2) Student Loan Availability: There has been talk of cuts to federal student loan programs. This would
be disastrous for education companies because they rely on federal loan programs.
But a recent report from the Congressional Budget Office shows a significant surplus of funds for 2013, which means that the Pell Grant program should not be affected by budget cuts in the near future.
A stronger economic environment, coupled with an accommodating Federal student loan program, should cause the for-profit education stocks to trade higher over the next 12 to 18 months.
Three rebound candidates
Today, I want you to consider adding these three education stocks to your portfolio.
As is the case with most turnaround investments, the stocks are not perfect. All three of these stocks are trading below their previous price points because of significant challenges. But as the market turns higher, these three stocks should give investors a great shot at doubling their investment over the next few quarters.
Apollo Group Inc. (NASDAQ APOL): Apollo Group is currently trading near $20, while analysts expect the company to earn $2.73 per share this year (fiscal year end is August 31), and $2.21 per share in the coming year.
The company has made some very painful (but necessary) restructuring decisions over the past year. In October, Apollo Group Inc (NASDAQ:APOL) announced that it would close 115 physical campuses and lay off 47% of its University of Phoenix employees.
On May 14, Apollo Group Inc (NASDAQ:APOL) received a letter from the HLC Institutional Actions Counsel, stating that the company would continue to be an accredited university for another 10 years. This positive announcement helps clear the way for stronger enrollment and better employment prospects for future graduates.
I look forward to the company’s next quarterly report, which should incorporate new
expectations based on this positive news.
Apollo Group Inc (NASDAQ:APOL) is currently trading at a single digit multiple, in an environment that is becoming much more conducive to growth. I expect analyst estimates to increase over the next several quarters, which should result in a higher PE multiple for the stock.
ITT Educational Services, Inc. (NYSE:ESI): ITT Educational Services is also trading with a single-digit Price / Earnings multiple as investors are skeptical of the industry. The stock trades at $23.97 with analysts expecting $3.94 in earnings per share this year, and $2.49 for 2014.
Similar to Apollo Group Inc (NASDAQ:APOL), management is working hard to trim excess and get back to a strong core business platform. In the last quarterly report, the company noted a 3.6% decrease in new student enrollment, along with a significant decrease in debt and net capital expenditures.
ITT Educational Services, Inc. (NYSE:ESI) is actively buying back its own stock, which should help to boost profits per share in the coming quarters. Over the past four years, the number of shares outstanding has declined 35%. This means that in time as the for-profit education industry rebounds, net income will be spread across a fewer number of shares, likely beating analyst expectations and sending the stock price higher.
Strayer Education Inc.: Strayer Education is one of the more expensive stocks in the group, trading at 13 times analyst expectations this year.
There is a reason Strayer Education Inc (NASDAQ:STRA) is more expensive–the company is much more stable than many of its competitors.
While Strayer Education Inc (NASDAQ:STRA) has seen a moderate decline in enrollment for the last two years, it has still remained well above the enrollment level of 2008 (before the industry came under pressure). The same can be said for the company’s revenue as tuition levels have remained steady.
Similar to ITT Educational Services, Inc. (NYSE:ESI), Strayer Education Inc (NASDAQ:STRA) is repurchasing shares aggressively. This makes good use of the company’s excess cash as the underlying business is still cash-flow positive.
As the employment market continues to improve and enrollment levels rebound, Strayer Education Inc (NASDAQ:STRA) is in a great spot to boost profits ahead of expectations, which will attract the attention of institutional as well as individual investors.
The time to act is now!
With for-profit education stocks trading at historically low price points, and the overall sector showing significant improvement, now is the time to add these stocks to your portfolio.
As investors start to put the pieces of the puzzle together (stronger employment, stable student loans, the need for higher education, higher profit potential for these companies), the stock prices should trade sharply higher.
We want to make sure to put our capital to work today, before valuations increase and the potential return rates are diminished.
Zachary Scheidt has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Three Education Stocks Poised For a Turnaround originally appeared on Fool.com.
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