Caution: These Stocks Are Still Teething

President Clinton's $21.7 billion package of tax credits and other child-care incentives appeals to more than middle-income families. It has increased enthusiasm on Wall Street for child-care stocks. "More government spending for child care is a big plus for the handful of publicly traded companies that provide the services," says Leslie Nelkin, an analyst at Furman Selz. The day after Clinton previewed his plan on Jan. 7, Nelkin put out buy recommendations on three child-care stocks: Childtime Learning Centers, Children's Discovery Centers of America, and Nobel Education Dynamics.

But while the Administration initiative and the growing demand for child care are positive signs for the $30 billion industry, investors should be cautious about plunging in. For all the images of happy tots at play, day care is a difficult business.

LOFTY P-Es. For example, Clinton's child-care plan is a long way from becoming law. The Republicans will likely propose a broad-based tax cut for parents rather than tax credits for child care. "Republicans won't discriminate against stay-at-home moms or be biased in favor of institutional child care," says Darcy Olsen, policy analyst at the CATO Institute, a conservative Washington think tank.

Another reason to be wary: Most child-care stocks are trading near all-time highs and have lofty price-to-earnings ratios (table). Take Bright Horizons and CorporateFamily Solutions, which manage corporate-based programs. As the leaders in the fastest-growing market and potential beneficiaries of Clinton's proposed $150,000 tax credit for companies providing on-site care, these companies have bright futures. For 1998, they each project double-digit revenue growth and expect to open at least 20 centers.

But shares of both companies have shot up since they went public last year. Bright Horizons' stock is up almost 50%, to 19, since its offering in early November, while CorporateFamily's stock has nearly doubled, to 23 3/8, since August. Corporate child-care stocks "have run up too much, too fast," Nelkin says.

BRIGHT SPOT. Keep in mind, too, that child-care stocks, which also include traditional day-care providers, are vulnerable to an economic slowdown. Corporations and individuals tend to cut back on child-care spending when their financial situations worsen. During the 1991 recession, child-care facilities lost enrollment. And corporate downsizing is a threat to existing centers. "The industry is overregulated, recession-prone, and price-sensitive," notes Gerald Odening, a Salomon Smith Barney analyst. Tuition costs have remained flat for the past 25 years, making it difficult for the companies to improve profit margins or expand services. In addition, the national chains compete with lower-cost nonprofits and mom-and-pop operations.

The one child-care stock that may still be undervalued is Nobel Education Dynamics. While the company offers traditional day-care services, it also has become the nation's largest nonsectarian private-school operator, with 130 elementary schools in 15 states. Nobel's goal is to keep its preschool graduates within its education system. "There's upside potential with this company now that it has solid management and a growth strategy," says Nelkin. And at 7 7/8, its stock is trading closer to its 52-week low, giving it an advantage over the rest of the sector.

Before it's here, it's on the Bloomberg Terminal.