DISCOVERING THE BEST EDUCATION STOCK(S)

Shareowner, Jul/Aug 2004

Education, like food production, is one of those industries that is hard to imagine 'going away.'

This Special Report is presented as a practical illustration of the process and judgments required when studying a collection of companies - from the same industry - to identify those with the most promising prospects for providing investors with an attractive rate of return over the longer term. Central to this illustration are judgements about each company's future growth, financial and operating fundamentals and valuation in the marketplace. Readers should always develop their own judgments about a company's future fundamentals and valuations before beginning to purchase any stock.

Readers are also reminded that there is always the risk of a sharp decline in a growth stock's price/earnings multiple - and share price - in the event of a surprising decline in a company's reported or prospective earnings growth, or, in the general stock market.

To minimize this risk, prudent investors who might consider purchasing such a stock(s) should also consider the merits of using a series of modest purchases spread out over several months, quarters, and even years rather than a single large purchase.

ShareOwner's Low Cost Investing Program (LCIP) was created to make such risk-reducing purchases cost effective iuith commissions starting under $2 per trade. Currently, some 6,000 subscribers have over $100,000,000 invested through the LCIP. - Editor

The forces driving the robust demand in the for-profit education industry are outlined in For-Profit, Postsecondary Education - Industry Trends article beginning on page 7.

Suppose that you consider those forces to be sufficiently strong to continue generating high demand for at least another 3-5 years. At the same time, you recognize that different companies in the industry may be more successful in capitalizing on that demand. You, therefore, want to narrow the field of stocks to those relatively few with the best reward and risk prospects.

This article illustrates ShareOwner's approach to identifying the highest quality stocks in the industry. As always, we begin our study with the historical growth fundamentals.

Growth Fundamentals

The charts above show the historical Revenue and EPS Profiles for the 7 public companies introduced in the Trends article on page 7. As well, Profiles are provided for the Apollo Group Inc.'s "tracking stock". Revenues and EPS for this stock are attributed to Apollo's internet-based educational programs operated as the University of Phoenix Online. Selected details of the tracking stock are available on page 15. Because of differing fiscal year ends among the seven companies, the latest annual data is reported for December 31, 2003 and estimated for those companies with June or August year-ends in 2004.

The Profiles are sorted by average historical growth rate (highest to lowest) during the 'benchmark period' for each stock. For revenue data, this period was judged to start with 1999. Somewhat different periods were sometimes used for benchmarking other data referred to in this article.

Above, the Profile rankings show all firms growing revenues at greater than 20% - except DeVry and ITT. As well, all firms have grown EPS at more than 20% - except DeVry and Strayer.

Note that some of the revenue and EPS growth rates are unusually high at well over 40%.

Financing Fundamentals

The ability of a company to continue growing revenues and earnings during the next 3-5 years is influenced by the money available from retained earnings and from potential borrowings.

Retention Rate. Six of the seven companies reinvest all of their earnings to finance operations and growth. Strayer retains 88% and pays out cash dividends amounting to 12% of earnings.

Borrowing Money. The chart on the next page detailing Reliance on Debt, shows investment in assets (less cash) for every $100 of a company's equity.

Note that values greater than $100 indicate reliance on debt financing; values less than $100 indicate that the company has more cash on hand than total debt outstanding. Here, Strayer, Apollo and ITT are indicated as having considerable unused debt capacity to finance additional growth or other priorities.

Operating Fundamentals

Asset Efficiency. A primary indicator of a company's capacity to grow revenues in the future is its historical efficiency in generating revenues from its assets; assets acquired with retained profits and borrowings.

The Asset Efficiency chart on the following page shows the historical trend in revenues being generated from every $100 of assets. Note that Asset Efficiency typically declines when a company acquires less efficient firms. Efficiency may rebound to earlier levels following a consolidation of operations.

Companies with the greatest efficiency in generating revenues from assets are: ITT, Apollo and Strayer.

Revenue Efficiency. The efficiency with which a company converts its revenues into earnings drives future EPS growth.

The Revenue Efficiency chart above shows the earnings generated for every $100 of revenues. Here, Strayer and Apollo have significantly greater efficiency in generating earnings from revenues than the other firms.