Don't Be Fooled: This Industry Is Still in Decline

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For-profit education stocks have suffered mightily over the past year on widespread concerns. At the heart of it is an ongoing concern over the very economic viability of the industry itself. Dropping enrollments and falling profits are accelerating, forming a snowball effect of sorts that has brought the entire sector to its knees.

More recently though, industry components including Apollo Group (NASDAQ: APOL), Bridgepoint Education (NYSE: BPI), and Strayer Education (NASDAQ: STRA) have actually rallied considerably off their recent lows. And, further excitement ensued when it circulated through the financial media that famed investor Dan Loeb may have taken a stake in Apollo, the embattled educator, which sent stock of the embattled educator up as much as 7% intra-day.

Unfortunately, it quickly became known that Loeb’s Third Point fund did not, in fact, make an investment in Apollo. Investors buying on the heels of this rumor are making a big mistake, and would be wise to avoid the sector entirely.

A dead-cat bounce by any other name…

… still a dead cat bounce. This is an investing adage that refers to fundamentally-damaged companies which see brief rallies in stock price. That’s my impression after seeing for-profit education stocks climb in recent months. There’s long been a bull case in place that these stocks are cheap, and based on their current valuations, they do seem inexpensive.

After all, Apollo and Bridgepoint trade for just 7 times trailing earnings, and Strayer is only slightly more expensive at 9 times trailing earnings.  These multiples certainly look compelling in light of that fact that the S&P 500 trades for an earnings multiple in the high teens.

Investors need to remember, though, that historical valuations are just a snap-shot in time. They don’t take into account the likely growth (or decline) of EPS going forward.

That’s why these for-profit education stocks are actually more expensive than they seem. Quite simply, earnings across the industry are collapsing, and that process hasn’t exhausted itself by any means.

Consider the recent developments from these companies, and ask yourself whether the trend is positive or negative.

Apollo said its third-quarter profit fell a whopping 40% from the prior year on a 16% drop in revenue year over year. In the same quarter, Apollo’s University of Phoenix saw total enrollment fall 17%, and new student sign-ups fell a massive 25%.

Strayer's first-quarter results saw revenue and diluted earnings per share fall 8% and 24%, respectively. Furthermore, Strayer’s total enrollment dropped 9% and its new student enrollments decreased 14%.

Ditto for Bridgepoint: the company’s own first-quarter revenue declined 11% year-over-year, and diluted earnings per share collapsed 27% from the first quarter of 2012.

Again, enrollments were the main cause of the company’s deteriorating financial performance. Total student enrollment at Bridepoint’s academic institutions dropped 17% from the first quarter last year.

Resist the temptation to catch these falling knives

Many investors are willing to wait for distressed companies to turn their businesses around in exchange for buying in at low prices. However, shareholders aren’t being paid to wait for this. None of these stocks pays a dividend. Strayer was the last to do so, having suspended its $4.00 per share annual payout in 2012.

Some of these companies will focus on cost-cutting to try to eke out profits going forward. For example, in the wake of its last quarterly results, Apollo announced it is targeting $300 million in cost cuts in fiscal 2013.

However, cost-cutting can only go so far. Continuing drops in student enrollments will virtually ensure lower revenue and profits in future quarters.

As a result, these stocks are not nearly as cheap as they seem. Unless they can each meaningfully turn their business around and get enrollments going in the right direction, there’s simply no need for investors to take the risk. There are plenty of stocks out there that are growing profits and rewarding investors with strong dividends. Save your hard-earned investing dollars for more deserving stocks.

The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Bridgepoint Education. The Motley Fool owns shares of Bridgepoint Education. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus