Pair Trade: Education and Training Services

For my explanation on pair trading, please see here.

Education and Training Services Industry

Education is always a key topic when a new President comes into office, and increased government spending along with a weak economy and tough job market sending people back to school, could bode very well for the education and training stocks. The sell-off in many of these names was due to worries that Federal Funds are needed to send many of the students to these programs, but worries about student loans have subsided and the growth story is still intact. The companies operating at the highest management efficiency ratios and best margins will be the best investments, as cash flow certainty is a key in this market.

Long: Apollo Group (APOL), $70.56: Apollo Corp trades at some rich metrics relative to the market, but is in-line with peers with a PEG of 1.63, and a P/S ratio of 3.57. Apollo stands out as the leader in the group, not just in market cap, but in sustainability and likelihood for future growth. Operating margins are at 23.86% and the ROE is 64.92%, both near the top of the group of 9 stocks. The technical picture is bullish, as shares broke out of a downtrend with a break of $65, and are now consolidating, ready for a breakout higher. Shares are only down 2.62% this year and we expect Apollo to continue to outperform the group.

Short: Career Education Corp (CECO), $14.91: Career Education shares are down more than 53% this year and this stock is the laggard in the group, but we expect to see underperformance due to poor management. It operates with margins of only 3.91% and an ROA of 4.46%, much lower than Apollo’s 28.75%. CECO shares have been making lower highs and remain in a downtrend.

Correlation: 53.1% correlation over the past 1 year.

Fight Card:

The Trade

APOL: Long 1 Feb. 09 $70/$80 Vertical Call Spread for debit of $4.25

CECO: Short 1 Jan. 09 $10/$17.5 Vertical Call Spread for credit of $4.40

Disclosure: no positions

Comments

[lony:]

Over the past 2 weeks, the stock price of the stronger APOL has increased 9% while the weaker CECO is up 24%. This appears to be contra the expectation. Is the trade in the money?
Also, is there a point at which you will stop out a pair that are not working as expected?
Thanks for your help

2008 Nov 28 04:57 PM

[Joe Kunkle:]

Each are up about 14% now, these take some time to play out as they are valuation calls. I will adjust the options trades if anything changes fundamentally with the companies that would change my opinion.

Jan 05 12:57 PM