For-Profit Schools: 1 To Buy and 2 To Avoid

Much to the displeasure of orthodox academia, for-profit colleges and universities have become major players in the higher education business.  In its entirety, the industry educates about 10 percent of American college students, and nationwide enrollment figures have more than doubled since 2000.


Annually responsible for preparing nearly 50,000 students for fields ranging from computer technology to veterinary sciences, Strayer Education, Inc. (NASDAQ: STRA) is one of the most successful for-profit educators.  Long-term shareholders had seen STRA jump from its IPO price of $10 to nearly $210 a share pre-recession, though the stock currently trades around half of this peak.  With a current P/E (12.1X) way below its 10-year historical average P/E of 30.9X, it’s possible that STRA is undervalued.  Looking at the company’s current P/CF (9.2X), which is below its 10-year average P/CF (24.5X), supports a similar conclusion.  It does not make intuitive sense for the company’s earnings and cash hoard to be undervalued, as both have grown rather rapidly over the last five years.  Specifically, EPS has grown by 95.3 percent and free cash flow by 90.1 percent.  This may be why mega-hedge fund manager Jim Simons increased his holdings in STRA almost 10 fold.  Seeing as Simons is one of the most successful managers of all-time, investors may be wise to follow suit.

One stock that investors should ‘hold’ right now if they have it seems to be Apollo Group, Inc. (NASDAQ: APOL), which has the right combination of value and growth at the current moment, though fears of a APOL-centered student loan bubble have investors uncertain.  APOL’s P/E (7.6X) and P/CF (5.7X) are below the industry averages of 13.0X and 6.0X respectively, and the company’s 3-year average revenue growth of 14.7 percent is above the industry average of 13.9 percent.  Additionally, free cash flows have grown a modest 18.4 percent since the recession and EPS has expanded by almost 40 percent.  Interestingly, APOL is different from many of its competitors due to the fact that its core school, the University of Phoenix, is web-based.  Though enrollment numbers at this school have fallen in recent months, online university is still the largest accredited institution in the U.S., serving over 380,000 students each year.  Hedge fund activity on the stock has been mixed, citing worries over a building student loan bubble that if popped, would affect APOL most heavily, due to the fact that about 85 percent of its students use federal student loans.  This percentage is almost 15 percent more than any of its competitors.  Managers like D.E. Shaw and Lee Ainslie are long, while the firms Axial Capital, Nantahala Capital Management, and Sandler Capital Management all hold put options on APOL.

Devry, Inc. (NYSE: DV) is a company similar more in nature to Strayer, though it has a larger student base, serving over 100,000 students each year.  Though the company’s P/E (9.2X) and P/CF (6.1X) ratios are below or at industry averages, the company could be a value-trap.  In other words, valuation ratios may be lower than average because of structural problems within DV.  In the company’s April earnings release, all major indicators of financial health fell – most notably year-on-year EPS by 33.3 percent.  DV leadership estimated that undergraduate enrollment fell 15.1 percent in the quarter, as new undergraduate signups declined by nearly 20 percent.  These staggering figures can be attributed to tighter government regulation on enrollment standards to tackle student loan debt.  Interestingly, Devry was the last major for-profit school to change its business model in accordance with these new rules, which may explain its larger-than-normal enrollment shrinkage.  Insiders have been dumping the stock; CFO Richard Gunst, and Senior VPs P. John Roselli and L. Ronald Taylor sold a total of 63,500 shares throughout February of this year.  While these transactions do not represent a majority of Taylor’s holdings, both Roselli and Gunst sold more than half of their total shares.

In order to make a play off of these three stocks, investors can use pairs trading, by going long STRA/short APOL, or long STRA/short DV.  While both moves should provide positive returns in the next 6-12 months, it may be best to stick with the latter.