Apollo Group Gets an 'A' for Earnings Quality

A few weeks ago Apollo Group (APOL - commentary - Cramer's Take) filed its 10-K for the year ended Aug. 31, 2003, and the results are truly a sight to behold. In fact, the firm's performance for the last several years has been museum quality.

That's why I am pleased to induct the Phoenix-based company into my Earnings Power Hall of Fame, where it joins circa-1990s Microsoft (MSFT - commentary - Cramer's Take) and Paychex (PAYX - commentary - Cramer's Take).

Through its subsidiaries, Apollo is the largest private institution of higher education in the U.S. Combined, its University of Phoenix, Institute for Professional Development, College for Financial Planning Institutes Corporation and Western International University instruct 211,000 students at 71 campuses and 121 learning centers in 37 states, Puerto Rico and Canada. Apollo's online program has a tracking stock that trades under the symbol UOPX on the Nasdaq.

Since the end of 1998, Apollo's stock is up 348%, which would have turned a $10,000 investment into $45,000. In contrast, the S&P 500 fell 12% during this period, grinding the same $10,000 investment down to $8,757.

Here are reasons to admire Apollo:

Strong revenue growth. For the last five years, top-line revenue has grown 30%, 26%, 25%, 30% and 20%, respectively.

High-quality accrual profit. The close proximity of defensive and enterprising profit to accrual profit (net income) means Apollo has authentic earnings power; i.e., it can self-fund and create value. The two are not the same, and both are hallmarks of a low-risk growth stock.



Forging an Earnings Power Staircase. Apollo is moving in an upper-right direction every year. When you see this kind of chart, you can be assured that not only is the company getting bigger, it is also getting better. Earnings Power Staircase companies are the real blue-chip stocks of Wall Street.



(To learn more about the Earnings Power Chart, check out my just-released book It's Earnings That Count.

High return on investment. Last year Apollo's net operating profit after tax rose $78 million, and its capital base went up $61 million, resulting in an amazing 128% return on incremental investment ($78 million divided by $61 million). The five-year average return is a lustrous 71%.

Pristine balance sheet. Companies that produce high-quality earnings don't need to borrow lots of money. In Apollo's case, it has enjoyed a net cash position for the last three years. (I treat capitalized operating leases as a form of debt.) Also, cash and marketable securities account for almost 60% of assets. Last, goodwill and other intangibles are just 3% of assets, and the company also has a positive tangible book value of almost $1 billion.

Tight controls over working capital. Apollo's investment rate in working capital has averaged a negative 16% a year for the last five years. This low -- and desirable -- rate is due to receivables turning over in just 26 days (down from 53 days in 1998). Importantly, creditors are not being stiff-armed: Apollo pays its bills in eight days.

Fixed capital needs are nil. In recent years, management has invested 10 cents of every dollar of incremental revenue in fixed capital. This modest investment rate in plant, property and equipment helps explain why the balance sheet is so liquid.

Modest stock-based compensation expense. Six percent in fiscal 2003, vs. 9% in 2002 and 14% in 2003. The downward trend is a plus.

Insider ownership. Although there has been lots of selling of late, insiders still own 22% of the company, according to Yahoo! Finance. Thus, any pain felt by stockholders is shared by the people running the company.

If you are a long-term cautiously greedy investor, benchmark the companies you own against Apollo. (This recommendation also applies if you own a lot of your employer's stock.) If they don't measure up, then maybe you should sell.

Of course, the past isn't always prologue. My next column will look at the pros and cons of buying Apollo at its current valuation.

A personal note: It is a privilege to write for RealMoney, which has so many smart and articulate contributors and readers. Thank you for reading my columns this past year. Best wishes to you and your loved ones for peace and prosperity in 2004.

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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 profit. (The Earnings Power Box is a trademark of Hewitt Heiserman.) At the time of publication, Heiserman didn't hold any 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].

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