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.