Education Stock Deserves to Go to Head of Class

If that's true, then Capella Education (CPLA) is gaining prestige. Founded in 1993 and publicly traded since November 2006, Capella offers 950 online courses and proper degrees in pragmatic fields like business, information technology and health services. First-quarter results for the company, reported May 1, show enrollment surging 23% vs. a year ago, to 23,496 "learners" as the company likes to call them. Sales increased a smidgen faster, by 24% to $65.3 million. Profit surged 35% to $5.5 million despite Capella installing new business intelligence software to handle admissions, billing, advising, contact management and, soon, financial aid. The software costs money upfront and might ding worker productivity for a quarter while staffers get used to the new system, but should pay off thereafter, says the company.

Management's stated goal is to increase enrollment and sales by 18% to 22% over the next five years while growing operating earnings by 25% to 30% as it makes more use of already-paid-for infrastructure. A tightening of consumer credit has hit colleges of late, but Capella seems better-positioned than traditional schools to collect its tuition. Its students are older than typical college-goers and have household incomes of $50,000 to $80,000. Most are pursuing masters or doctoral degrees. Around 17% get reimbursement from employers. Since most take a class or two per semester at $300 to $600 per credit, depending on the program, tuition bills fall easily under the maximums for federal loan programs. Only 3% of students use private loans.

Wall Street seems to think management's goals are easily attainable, at least in the short term. Analysts expect sales to surge 22% this year and 22% next year, and see profits climbing 24% this year, considering the software investment, and 28% next year. I recommended Capella shares in a July 2007 round-up of school stocks. They've gained 37%, compared with an 8% decline for the S&P 500 index. They fetch an immodest 38 times this year's earnings forecast, down slightly from 41 times earnings when I first recommended the stock.

The stock carries risks. Capella depends on doctoral students for half its sales and most of its profit, but its bachelor and masters business is growing faster, so margins might get crimped. Internet ads, which the company depends on for luring new students, are becoming more expensive. And there's little but the potential for brand dilution to stop prestigious schools from expanding their online offerings. Lately, though, Capella has performed better than expected, beating analyst estimates by an average of 8% over the past four quarters. If the stock isn't an obvious bargain, the company at least has plenty of room to grow. Its student body, not bounded by the availability of desks and chalkboards, is still well smaller than those of many traditional colleges.

The company turned up recently on a search for promising midcaps, or companies with market capitalizations (the cost to buy all of their shares) of between $1 billion and $5 billion. The eight companies that made the cut boast recent share-price momentum, ample returns on equity and valuations that seem reasonable when compared with growth rates. Run the search anytime you like using SmartMoney's stock screener and the full list of criteria.

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