Dear Reader,

Today’s dispatch will probably be shorter than usual, since I spent most of the morning doing the research and calculations for the table below.

The subject of today’s issue is education and an important trend in education that’s been taking root over the past few years.

Traditional university degrees have become prohibitively expensive today. Even if students get a loan to pay for school, they find themselves up to their eyeballs in debt when they graduate – with no chance of paying off the loan for decades, in some cases (if at all). So students yearning to learn valuable skills for the marketplace have turned to the for-profit private sector in droves to help solve their problem.

Recognizing that this trend toward online and for-profit education will likely accelerate in years to come, I decided to take a look at the companies operating in the space to help you figure out if this might be a good place to invest.

I only had time to look at U.S.-based companies (apologies), but what I’ve come up with is a group of 17 publicly traded companies that comprise what I’m calling the U.S. Education Services Sub-Industry. Some of these companies only operate online, but most provide online services as well as on-ground campuses.

Here’s a breakdown of the “industry.”

Education Services Sub-Industry (U.S. Publicly Traded Companies)
Company
Ticker
Stock
Price
Market
Capitalization
Sales (TTM)
Earnings
(TTM)
Basic
EPS
P/E
Ratio
Earnings
Yield
Current
Ratio
Apollo Group APOL $42.29
$6,218,913,660
$4,742,162,000
$612,394,000
$3.98
10.6
9.4%
1.3
Career Education CECO $20.48
$1,664,298,803
$2,023,653,000
$209,042,000
$2.54
8.1
12.4%
1.3
DeVry DV $47.40
$3,376,615,409
$1,804,746,000
$245,365,000
$3.45
13.7
7.3%
1.2
Corinthian Colleges COCO $7.82
$689,149,152
$1,634,566,000
$136,783,000
$1.56
5.0
19.9%
0.8
Education Management EDMC $12.57
$1,795,622,401
$2,377,338,000
$141,885,000
$1.04
12.1
8.3%
1.4
ITT Educational Services ESI $71.28
$2,394,301,330
$1,499,827,000
$351,740,000
$9.76
7.3
13.7%
1.3
Strayer Education STRA $214.48
$2,978,627,033
$578,736,000
$120,561,000
$8.87
24.2
4.1%
1.6
Lincoln Educational LINC $14.15
$369,128,404
$611,088,000
$63,645,000
$2.43
5.8
17.2%
0.9
Universal Technical Institute UTI $16.51
$399,913,244
$416,215,000
$29,198,000
$1.22
13.5
7.4%
0.9
K12 LRN $25.64
$780,641,388
$368,315,000
$22,184,000
$0.75
34.2
2.9%
3.7
Capella Education CPLA $79.42
$1,330,018,149
$384,502,000
$54,529,000
$3.26
24.4
4.1%
4.9
Nobel Learning Communities NLCI $7.11
$75,015,484
$225,814,000
$2,354,000
$0.23
30.9
3.2%
0.3
Bridgepoint Education BPI $14.62
$799,533,004
$589,048,000
$107,051,000
$1.98
7.4
13.5%
1.9
Learning Tree International LTRE $10.82
$148,820,704
$124,865,000
$1,874,000
$0.14
77.3
1.3%
1.7
Grand Canyon Education LOPE $18.40
$842,259,356
$295,769,000
$33,709,000
$0.74
24.9
4.0%
1.3
Princeton Review REVU $2.38
$122,327,578
$161,881,000
($27,792,000)
($0.82)
NA
NA
0.9
American Public Education APEI $26.82
$495,574,328
$173,689,000
$28,064,000
$1.54
17.4
5.7%
3.5
Total
$24,480,759,426
$18,012,214,000
$2,132,586,000

[Note: In the table above, earnings reflects the net income available to common shareholders before extraordinary items. Basic EPS was calculated using the basic weighted average shares over the previous four quarters.]

As you can see in the table, these 17 companies reflect a combined market capitalization of $24.5 billion and generate $18 billion in annual sales and $2.1 billion in earnings. The three most attractively priced companies in the space, based on a multiple-of-earnings approach, are Corinthian Colleges (COCO), ITT Educational Services (ESI), and Lincoln Educational (LINC).

Even though COCO and LINC have higher earnings yields than ESI and have shown stronger growth in the recent past (and have much smaller market caps and the capacity to grow faster in percentage terms in the near future), their balance sheets indicate some short-term liquidity problems and greater risk than ESI.

If I were to invest in the education services sub-industry at this point (which I haven’t yet but may in the near future), my pick would be ITT Educational Services (ESI). The company’s TTM sales of $1.5 billion reflect an increase of 47.7% from 2008 results. And TTM basic EPS of $9.76 is an 88.4% jump from 2008’s figure of $5.18.

What’s more, the company generates close to $9 per share in free cash flow and has a pretty good-looking balance sheet with no short-term liquidity issues. The capital structure appears a little risky for my taste, but I could probably get over that, given the 54.4% return on assets and 229% return on equity. Add all that to the fact that ESI is trading just about at its 52-week low, and the company definitely has potential as an investment, in my view.

Remember, I’m not saying you should load up on shares of ESI, but I would recommend taking a closer look at it if you are thinking about getting positioned in a solid company that should benefit from the larger trend of a growing market in for-profit education.

Keeping with the education theme of today, I’ll now turn it over to Vedran Vuk for his take on “How to Combat Watered-Down Degrees.”

How to Combat Watered-Down Degrees

By Vedran Vuk

Yes, higher education continues to get worse. But I don’t buy the hysteria that this will mark the decline of Western civilization. The business world in particular has worked around watered-down degrees for a long time. Today’s college grads are filtered through internship programs. A college degree no longer guarantees a job. Instead, a diploma leads to an internship, which hopefully leads to a job.

Another adaptation has been the value placed on non-college educational certification titles, such as the CPA (Certified Public Accountant) and the CFA (Chartered Financial Analyst). These designations are far more important than an undergraduate or even graduate degree. 

As some readers already know, I’m pursuing a MS in finance at Johns Hopkins University. At the beginning of one class, the professor asked the students to introduce themselves and explain their reasons for acquiring either an MBA or MS finance. One equity analyst from a big financial firm in town gave the most educated answer. She said, “I’m getting a MS finance degree so that I can pass the CFA exams.” The degree was simply a means to gaining enough knowledge to pass the more important accreditation exams. And her goal is well thought-out. A non-CFA graduate will be incomparable to one with the CFA title.

The business world isn’t dumb. It realizes that college degrees alone are worthless – even on the graduate level. Further, it realizes that GPAs are meaningless standards. A 2.5 in some schools can be more difficult to earn than a 4.0 in others. Hence, CPA and CFA certifications have surpassed even graduate degrees as a way of demonstrating superior proficiency.

And while anyone can get a graduate degree slowly, one has to actually learn something to conquer the CPA and CFA exams. Take, for example, the CFA’s pass rates. The certification requires passing three separate tests. Since the tests began in 1963, the average pass rate for the Level I test has been at 44%, Level II at 49%, and Level III at 63%. Each test must be taken sequentially after passing the previous exam.

If 100 people took the tests together, only 14 would pass all three tests on the first time. I can’t recall any college class or test where 86% of the students failed. Also, remember that only the best consider the CFA exams. The guy who barely graduated college between keg stands and bong rips is not exactly lining up to take them. He doesn’t stand a chance. In 2010, many unemployed, less qualified candidates entered into the test pools attempting to cheaply boost their resumes. Naturally, the pass rate for the Level I exam dropped to 34%. At this rate, assuming the other pass rates remained the same, only 10 out of 100 passed all three on the first try. 

As prerequisites, the CFA only requires a bachelor’s degree and the CPA requires 150 hours of college courses, about 5 years. On top of that, real-world experience is also a requirement. The process is a great way for excellent grads to stand out without wasting thousands on further tuition. The studying can be done on your own, with perhaps only a class or two to fill in the gaps.

Further, the certifications level the college degree playing field. Many talented people simply didn’t have the money to attend Harvard or Princeton and had to choose local state schools instead. While a state school diploma may not be impressive on a resume, the CPA and CFA exams are equivalently respected by everyone. They allow people to prove their merit instead of proving the size of their parents’ pocketbooks.

The point is to prove what you know. As degrees get worse and worse, I wouldn’t be surprised to see similar certifications becoming dominant in other fields as well. 

Chris again. Thanks, Vedran. Now, dear reader, it’s getting late and I must run. As is our customary farewell, before I go I would like to thank you for reading and for subscribing to a Casey Research service. Until tomorrow…

Chris Wood
Casey Research, LLC