Continuing Education

When markets are falling, writes Dianne F. Lob, of Bernstein Global Wealth Management, in a recent letter to clients, "it's only natural to want to 'do something.' But while trying to time markets may sound like an alluring strategy, it is almost impossible to get right." So what are you to do? I suggest you invest part of your portfolio, right now, in industries of the future, not those of the present.

Educated guess

Which sectors will thrive over the next decades? Technology, of course, but there are drawbacks. The industry is super-competitive, choosing individual winners is difficult, and volatility is extreme. In 1949, Benjamin Graham, Warren Buffett's mentor and the best financial mind of the 20th century, wrote that it wasn't hard to predict that Americans would be doing a lot of flying on commercial airplanes. But he was skeptical that airlines, which were intensely competitive and required huge amounts of capital for new equipment, would be good stocks to buy, and he was right. High-tech today may fit the airline model.

What about health stocks? An aging America will need more drugs, medical devices and hospital care. But will health-care shares be able to overcome serious political risks?

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That leaves education. In an age when human capital keeps growing in importance, education is the best investment for individuals who want to increase their earning power. Again, there are political risks -- not that government will depress earnings through taxes and regulation, but that government, through tax-funded schools and universities, will use its monopolist position to compete with for-profit education firms.

Even so, I've liked for-profit education stocks for a long time. In 1995, I wrote in the Washington Post, "My candidate for the hottest industry in 2005 is education." On February 1, 1995, Apollo Group (symbol APOL), the strongest player in the industry, traded at a price of $1.32 a share, adjusted for later splits. Ten Februaries later, the stock was at $80, which is roughly where it remains. In the parlance of Peter Lynch, the former manager of Fidelity Magellan fund, that's a 60-bagger.

Not all education stocks have done as well. Companies lured into the business of managing public schools under contracts with local education authorities -- such as Education Alternatives and Edison Schools -- got clobbered. Education Alternatives changed its name to the Tesseract Group and later filed for bankruptcy.

Edison, founded with great fanfare in 1992 by former magazine publisher Christopher Whittle, intended to start a chain of low-cost private academies. When Whittle couldn't make the numbers work, he turned to managing public schools, took Edison public, lost a lot of money, then was rescued in a buyout by a Florida pension fund in 2003. Most investors were big losers. But Whittle and his partner, Benno Schmidt, a former president of Yale, have persevered. The now privately held firm served nearly 300,000 students last year, providing such services as tutoring for children in failing schools.

More typical of education companies over the past decade is Renaissance Learning (RLRN), which sells educational software to secondary schools. The firm, started by a husband-and-wife team in Wisconsin in 1986, went public in September 1997 at $6.50 a share and was trading at roughly double that price in February. Renaissance, like most education firms, is small, with revenues of about $100 million and a market value of $400 million. But the company has no debt, has been profitable every year since the IPO and even pays a dividend (the stock yields 2%).

Established winners

These examples illustrate the breadth of for-profit education. Apollo's business is to instruct people who have already joined the workforce but want to earn a bachelor's or advanced degree. Its main brand, University of Phoenix, is the largest for-profit university in the U.S., with about 100 campuses and an extensive system for online teaching.

DeVry (DV) and ITT Educational Services (ESI) also compete in this sector, with slightly different target audiences. All three have done well. DeVry's stock rose 92% for the 12 months to February 1, and ITT has more than tripled over the past five years. Both stocks have a market value of a little less than $4 billion, while Apollo's is about $12 billion. All three are established companies in a market that will continue to grow faster than the economy. Value Line Investment Survey estimates sales increases for each of about 10% annually for the next five years, with earnings rising a bit faster.

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Secondary targets

Two other companies, Career Education and Corinthian Colleges, have been struggling. But a third, Strayer Education (STRA), with much lower revenues (just $320 million in 2007), has been a sensational success. Strayer's Robert Silberman, who was Morningstar's 2007 CEO of the Year, has boosted enrollment at the Arlington, Va.-based chain of post-secondary schools to 31,000 on 47 campuses. Per-share earnings have tripled since 2000, and Value Line sees annual earnings growth of 17.5% for the next five years. Like Apollo and DeVry, Strayer has no debt.

While the for-profit university market is booming, the elementary and secondary school market, with far more potential, languishes. No firm has come close to building a system like that of Apollo or even Strayer. The most attractive kindergarten-to-12th-grade company is Nobel Learning Communities (NLCI), which operates 158 private schools around the country. Nobel is small (with a market value of just $135 million), but it has grown steadily. The stock has gone from about $3 a share at its low in early 2003 to about $15 in mid February.

Any company that manages to create a powerful brand in the K-12 market stands to become a major business. A 5% market share would mean some three million students, and at $10,000 each, we're talking $30 billion in revenues, or roughly ten times the size of Apollo and 150 times the size of Nobel.

But how to get there? Perhaps by starting with post-secondary education and moving down the age ladder. Or by starting with child care -- as Bright Horizons Family Solutions (BFAM) has done successfully in workplaces -- and moving up. Or by focusing on after-school tutoring or test preparation, as Kaplan does, and then sliding into the regular school day. Kaplan, a unit of the Washington Post Co. (WPO), now has twice the revenues of the newspaper itself.

Some of the smartest investors in the world, including Buffett, who owns a big chunk of the Post, understand the potential of for-profit education. Consider the initial public offering last December of K12 (LRN), funded by Michael Milken, the former junk-bond expert who has been building an education powerhouse with his private company, Knowledge Universe Education. K12, founded in 1999, offers an online curriculum that stresses traditional education to home-schoolers (of which there are more than one million in the U.S.) and to kids at charter and conventional schools.

Similarly, Pearson (PSO), the London-based firm that owns the Financial Times and Penguin Books, has aggressively moved into education, providing textbooks, software and other learning materials in math and reading for 18 million U.S. students. Another division scores more than 100 million tests a year.

Spending on education rises year after year, so its stocks tend to be a safe haven, even in a downturn. For example, shares of Apollo and Career Education rose during the 2001 recession. In January of this year, when the broad market took a drubbing, most education stocks held up nicely. (An exception was Corinthian, whose shares dropped more than 40%.)

Value Line recently ranked educational services first among the 97 sectors it reviewed. Four of the ten stocks that Value Line follows rank highest for timeliness, meaning they are among the 100 best stocks in all industries for year-ahead results.

Truly long term

But year-ahead isn't my point. Education is an investment for the next ten, 20 or 30 years. The business will keep growing as Americans become more dissatisfied with their kids' schools and as workers upgrade their skills after high school or college to keep up with changing technology.

The sector is too small to have its own specialized mutual fund, so you'll have to put together your own little diversified portfolio of, say, Apollo, Bright Horizons, K12, Nobel, Pearson and Renaissance. Sock it away for a decade and then take a look. You'll get an education in smart investing.

James K. Glassman is a senior fellow at the American Enterprise Institute.