The ABCs of Education Stocks

This relatively new sector is growing fast

By the time you're done, you could shell out what amounts to the gross domestic product of a small country for your kid's education. Tuitions are astronomical and rising faster than inflation, and even if your children are in public school, you'll still be paying plenty even during the pre-college years through your property taxes. So why not consider an investment that may allow you to recoup some of those costs? Today's lesson: education stocks.

Investors don't usually think of education as a stand-alone investment sector such as energy or technology. But the stocks are gaining momentum--and Wall Street's attention. "This is an industry that, from a stock market standpoint, didn't exist in any meaningful way five or six years ago," says Peter Appert, an education analyst at Deutsche Banc Alex. Brown in San Francisco. The sector isn't just about textbook publishers such as The McGraw-Hill Companies (which also publishes BusinessWeek). It also encompasses vocational and corporate-training companies. And the group runs from blue chips such as USA Education (commonly known as Sallie Mae) to upstarts such as SmartForce, an online corporate-training outfit.

These stocks should be on your radar screen. While the rest of the market has languished, the education sector until recently has been on a tear. Appert has created a unique index tracking the performance of 32 issues, including six subsets, such as education-software stocks and corporate-training and e-learning companies (table). The index gained 15.5%, driven mainly by a renewed focus on education by elected officials, improved educational funding, and strong enrollment-growth trends, says Appert. The index was up another 16% by July, but the stocks have lost nearly all of that in the downturn since. The best-performing slice of the index--and the one with the brightest future--is post-secondary, for-profit education stocks such as Apollo Group or Corinthian Colleges, "a tiny slice of the pie that is growing very quickly," says Appert. That sector-within-a-sector is up 46% this year. An economic slowdown actually improves these companies' outlooks because as unemployment rises, more employees seek to upgrade their skills to sharpen their job prospects. The 10 companies classified as education software, such as Lightspan and Plato Learning, are up 11.3% this year. And, led by Plato Learning and Lightspan Partnership, the education-software sector has gained a like amount. Corporate-training stocks are the laggards, down 46.9% so far.

"A NICE ENTRY POINT." It's true that the group has tumbled in recent few weeks along with the overall market. But the sell-off "provides a nice entry point for investors," argues Gregory Cappelli, an analyst at Credit Suisse First Boston. "These stocks offer an attractive business model, with solid top-line growth opportunities, impressive pricing power, and strong free-cash flow." One of Cappelli's top picks is Apollo Group, parent of the for-profit University of Phoenix. It's one of the sector's "fastest-growing, high-quality companies in the sector," and it's planning to spin off its University of Phoenix Online division as a tracking stock. Apollo stock is trading at roughly 31 times next year's earnings, down from more than 40 times earlier this year.

Other favorites include Career Education and Corinthian Colleges--both private, for-profit post-secondary educators that have beaten Wall Street estimates for the past few years. Still, with some of these stocks up more than 50%, you need to be cautious about what you're buying. Lou Stanasolovich, president of Legend Financial Advisors, is a fan of Sylvan Learning Systems. Sylvan designs individualized tutorial programs for children through franchised and company-owned centers. Its financial results look good: For the six months ended on June 1, revenues rose 59%, to $250.8 million. By July 30, the shares had hit a new 52-week high of $28.99--which amounts to a 60% jump this year. Next year, consensus earning estimates calling for a 19% increase.

While corporate-training stocks have been in the dumps, some analysts think the downsizing of U.S. companies will give the group a boost. Aaron Harris, a portfolio manager at Villanova Capital, is keen on an e-learning company Skillsoft. The Nashua (N.H.) company provides training courses that are accessible online. "Instead of shipping all of your salespeople to Phoenix to teach them about your bells and whistles, you can can teach them online," he says. "It will improve labor productivity and cut training expenses." In August, Skillsoft said that revenues soared 161%, to $9.4 million, for the fiscal 2002 second quarter from a year earlier. The company is still losing money, but at a slower rate. Skillsoft says it expects to make a profit by its fiscal fourth quarter.

Not all education stocks are considered buys. Stanasolovich, for instance, argues that Strayer Education in Washington, D.C., is overpriced. "You've got too little earnings growth and declining estimates," he says. "It has a valuation like a tech stock." Strayer University offers undergraduate- and graduate-degree programs on 14 campuses in Washington, D.C., Maryland, and Virginia. It also offers real-time online courses via the Internet through Strayer Online. The company's shares rocketed 76%, to a high of $54.70, in July, but they, too, have since drifted downward.

As publisher of the best-selling Harry Potter books, Scholastic has enjoyed a lot of success recently, and some observers might think its long run is nearing its end. But Scholastic's other divisions--technology-based products, teacher materials, videos, and toys--are also humming, says Appert. The publisher operates a successful book-club program that sells books to children for up to 50% off retail prices. One of the company's key offerings is Read 180, a computer-based product that helps kids who are reading below their grade level. Appert believes Scholastic will benefit if President Bush's educational-spending plans are enacted.

That's anything but a sure thing. But you can count on rising school enrollments and demand for more and better education and training programs for both adults and kids. It's reason enough to study up on education stocks.

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