The Sun Shines on Apollo Group

Lastly, valuation. Because of Apollo's strong performance over the last several years and expected earnings growth of almost 24% a year for the next five years (based on the consensus estimate of the 14 analysts Zacks surveyed), this is one pricey company.

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The Earnings Power 10-Minute Test

To illustrate Apollo's rich valuation, here's a simple test I like to perform. I call it the Croesus Test, after King Croesus of Lydia, who was known for his wealth and the prosperity of his kingdom. There are four steps.

On the basis of 176 million shares outstanding and a $44 stock price, Apollo's market value is $7.7 billion. This means that if you buy the entire company (remember, you're as rich as Croesus), then it will cost you $7.7 billion.

Next, we'll assume you own Apollo for a decade and then you sell to another Croesus. If you want to make 15% a year on your investment, then at the end of year 10, Apollo's market value must be $31 billion.

Now, pick a terminal price-to-earnings ratio. For our purposes here, I'll say Apollo sells at 17 times earnings. Thus, earnings in year 10 must be $1.8 billion. (Just divide the $31 billion market value by 17.)

Now the sanity test. If Apollo earns $204 million this year as expected, then to reach year-10 earnings of $1.8 billion, earnings must go up nine-fold. Can Apollo pull it off? Maybe, but to achieve this kind of earnings growth is a Herculean task. The number of companies that are able to compound their earnings at 25% a year for 10 years are precious few.

To sum up, I want to own Apollo because it is a Staircase company. But given its rich valuation, I'll just buy a few shares now with the hope of establishing a larger position if the stock falls to the low $30s. Also, I want to find that lone analyst.

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Hewitt Heiserman has been a financial analyst for 15 years and has worked for Fidelity Investments, Simplex Time Recorder, American Holdco and Breakaway Solutions. He is now writing a book on the Earnings Power Box, an analytical model he created to gauge the quality of a firm's profits. (The Earnings Power Box is a trademark of Hewitt Heiserman.) At the time of publication, Heiserman had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Heiserman appreciates your feedback and invites you to send it to [e-mail].