For-Profit Education Stocks May Not Be Worth The Risk

 |  Includes: APOL, CECO, COCO, DV, ESI, STRA
by: Insider Monkey

ITT Educational Services Inc (NYSE:ESI) is an education and training services company with a $1.59B market cap. Richard Blum’s Blum Capital Partners had more than 17% of its portfolio invested in the company at the end of the second quarter. The stock was also popular with Robert Joseph Caruso’s Select Equity Group, Cliff Asness’ AQR Capital Management and Jim Simons’ Renaissance Technologies. ESI reported its third quarter revenue recently. It was $360M, down from $387M the previous quarter. The stock recently traded at $59.15. Analysts estimate the stock will top $70.71 within the next 12 months. To find out whether ESI is a good deal, we are going to look at the company in closer detail, as well as its closest competitors – Apollo Group Inc (NASDAQ:APOL), Corinthian Colleges Inc (NASDAQ:COCO) and DeVry Inc (NYSE:DV).


First, we will look at the P/E ratio. This metric divides a company’s share price by its earnings per share – the lower the number, the better. P/E ratio indicates how many times its earnings a company is trading at. If the P/E ratio is high, the stock could be overpriced, so the lower the better. Of the companies we looked at, COCO had the lowest forward P/E ratio, coming in at 7.38. ESI was a close second at 7.81, followed by DV at 9.08 and APOL at 13.17.


We used beta as a measure of risk. A beta of 1.0 means that the stock moves with the market. The higher a stock’s beta, generally, the more volatile the stock, and, as a result, the more risky. A lower beta tends to indicate that the stock moves more independently from the market. APOL has the lowest beta of the companies we looked at. It has a beta of just 0.38. DV was next at 0.61, followed by ESI at 0.67 and COCO at 1.06.


Next, let’s look at the earnings growth consistency and expectations. Expected growth estimates can be wrong. In fact, they are frequently overstated, but they can be useful when comparing companies or comparing a company’s performance relative to its industry. ESI’s earnings grew 35.9% over the last five years, compared to 23.5% for its industry. ESI is expected to grow 12.5% per annum over the next five years, vs. the industry’s 17.4%. In comparison, APOL grew just 14.8% over the last five years and is expected to grow only 10.3% over the next five. COCO shrank -5.5% over the last five years. Its earnings are expected to grow by 5% over the next five years. DV grew an impressive 46.7% over the last five years and is expected to grow just 10.4% over the next five, beating out DV and COCO (just barely).


Stocks that are favored by hedge funds tend to outperform the market by a few percentage points on the average. Of the companies we looked at, APOL was the most popular. Of the 300+ hedge funds we track, 24 had positions in APOL at the end of the second quarter. ESI was next at 17, followed by DV at 16 and COCO at 10.


For-profit education stocks look cheap when we only consider their valuation ratios and projections. However these companies are under a lot of scrutiny recently. Careen Education Corp (NASDAQ:CECO) declined 60% this year and now has a PE ratio of 4. The stock is “expected” to hit $18 next year from around $8 today. However, CECO’s CEO recently resigned and regulators are scrutinizing the company. We don’t think estimates are nowhere close to reality and don’t sufficiently account for huge risks in the industry. Other stocks in the industry, like Strayer Education Inc (NASDAQ:STRA), also have attractive multiples. We aren’t comfortable with assuming directional risk in these stocks. One alternative is to have long positions in ESI and COCO hedged by short positions in APOL, DV, and STRA. We even find this very risky. We recommend investors to stay away from for-profit education industry at the moment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.