Back to School With Education Stocks

Educations stocks graduate to new levels of trading this week, but shares in the sector remain volatile investments.
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NEW YORK (

TheStreet

) -- Shares of post-secondary education companies have been trading lately as if investors were college students hopped up on Red Bull and ephedrine.

Is the action indicative of a sustainable rally, or will these stocks crash and burn like students after an all-nighter?

The volatility is a textbook lesson in what happens to the stocks of many heavily regulated sectors.

In the case of for-profit colleges, it's the Department of Education's outsize role in setting student-loan funding policy. The bureau is slated to promulgate rules that would for the first time set limits on student-loan financing based on graduation-rate benchmarks.

The government had previously proposed a formula -- not yet in the books --that would require 70% of an institution's students to complete their degree programs and 70% of graduates to find jobs in relevant fields in order for the students of for-profit colleges to be eligible for federal student-loan financing.

But word leaked Tuesday from Washington -- and the rumors found their way into reports put out by Credit Suisse and Signal Hill -- that the Department of Education might institute a more lenient formula. The graduation rate to be applied in the formula might only be 50%, rather than 70%.

The Department of Education was expected to send a version of its proposal to the Office of Management and Budget in April or May.

Shares of

Education Management

(EDMC)

led returns in sector on Tuesday, gaining 13.4%. More than a million shares of Education Management were traded on Tuesday, five times daily average volume in the name.

DeVry

(DV)

gained than 10% Tuesday on volume of more than 3.2 million shares -- that's versus an average daily volume of about 600,000 shares.

Credit Suisse raised its rating on DeVry to a buy.

Tuesday's big day of may cause some investors to hit the books on these companies.

On the one hand, it all comes down to your stomach for betting on the outcome of federal policy.

"We've heard some similar things, but nothing has been substantiated, and a lot can still happen, so it's hard to know what the final regulations will look like," said one education stock analyst who did not want to be quoted on a competitor's research.

Jerry Herman, of Stifel Nicolaus, who has covered education stocks for 15 years, said, "Our position has been that there would be some easing of language over time, but it still remains a sensitive and volatile issue with a long way to go before the finish line."

Herman said the larger message from the Department of Education hasn't changed: it aims to heighten its scrutiny of education companies.

If the government ultimately decides to use any benchmark formula to regulate studen-loan funding, it present many hurdles to for-profit colleges. "This is still challenging for education companies, so it's not like it's off to the races now," Herman said.

Education Management shares were flat on Wednesday morning and back to normal trading. DeVry shares were down 2%.

Apollo Group

(APOL)

, parent of the University of Phoenix and the largest company by market cap in the sector, was down 2.5% on Wednesday, or $1.45 per share, after gaining close to $2 on Tuesday.

ITT Educational Services

(ESI) - Get Report

shares went from being one of the market's biggest gainers on Tuesday to one of its biggest decliners Wednesday. In afternoon trading, the stock was down 4.5% after losing 10% in the previous session.

Despite the recent rally in education shares, the sector still suffers from depressed stock-price multiples and uncertain growth prospects.

Stifel's Herman said that, after the recently rally, education stocks are tading at 14 times projected earnings over the next 12 months, on average. In mid February, sector multiples reached an all-time low of 12.2 times earnings. That's versus a historical norm of between 20 to 25 times 12-month forward earnings, according to Herman.

He also noted that the sector has matured, and growth rates have therefore slowed. "It's still a relatively new industry," Herman said, "but volume growth in the mid 20% range is above a sustainable level."

One example of the current gap between multiples and growth potential is

Corinthian Colleges

(COCO)

. Corinthian shares are trading at less than 10 times earnings, yet some analysts are looking for growth as high as 27% this year.

Shares of Corinthian were down 1.5% at midday Wednesday, after being among the biggest gainers in the education sector on Tuesday.

Herman thinks multiples of 15 to 20 times forward earnings are sustainable for education stocks.

Overall, the sector has gained 30% this year -- and Tuesday's action marked the biggest one-day ascent in that steady year-to-date climb.

Analysts say Tuesday's volatility is likely here to stay. Downside issues still loom, making education stocks ripe for a correction, analysts say.

Given the recent trading action, you could say school is in session for these stocks. Still, it's a test for students of the markets to time their play in these volatile shares.

-Reported by Eric Rosenbaum in New York.

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