A headline I came across this morning sums up the market mentality today: "Stocks Rally on Europe Hope." But since when did investing become about hopes and dreams and not about buying undervalued businesses? The market is trading 400 points higher to start the week. Last week, the Dow dropped more than 400 points in a single day. I'm willing to bet that some of the same folks who were selling into that selloff last week are likely buying into the rally this week. Apparently, it was prudent to sell XYZ at $25 a share last week because there was little hope for Europe. Now with more hope, it's also prudent to buy XYZ at $28 a share this week.
As silly as the above transaction is, it happens all the time. With as much certainty and conviction as I can muster, I can tell you that this is absolutely not the way to invest. Unfortunately, the market is very good at making investors feel dumb. More than a month ago, I picked up Goldman Sachs (GS) at $118 a share. Last week, the shares were approaching $90 as folks rushed to dump shares of the world's premier investment banking franchise without any regard to the fact that GS was trading for 70% of book value. Unless you believe Goldman has become a second-tier bank -- I believe its current issues are just temporary -- the business was absurdly cheap.
You don't get many chances to buy Goldman at 70% of book value. Even though third-quarter earnings results are probably going to be well below original estimates, if anyone can figure out how to earn a profit in a changing environment, it is Goldman. Today, the shares are being snapped up at $103, which is still a great price. If the share prices remains at such attractive levels, management may take a page from Buffett and announce a buyback of stock -- especially if the global economy doesn't give them opportunities to put capital to work attractively elsewhere.
Instead of betting on hope and future macro events, bet on dependable businesses that are being offered at prices well below normalized intrinsic value. Education stocks have been pounded over the past several months as accusations mount that loose enrollment procedures were practiced in order to boost federal funding issues. The issue is serious and will likely lead to reform, but shares are trading as if education is a dying industry -- and as if all companies are the same.
But they're not. For example, Strayer Education (STRA) is quality name in the industry that is headed up by the able Robert Silberman. It focuses on in demand programs such as business/economics, Information Technology (IT), health administration and accounting.
Thanks to booming enrollment, the company's earnings per share (EPS) grew from $1.55 in 2001 to $9.70 in 2010. I think it's very safe to say that such future growth rates are thing of the past. Regardless, it's prudent at this juncture to assume that enrollment growth will be minimal -- at least until the cloud of regulatory uncertainty disappears. But I also think Strayer is going to continue grow once the uncertainty disappears. So far, default rates appear to be in line expectations. Of course, any surprise increase in default rates will change the scenario. Its shares have pulled back from $182 to $84 today to yield 5% and 9 times earnings.
Another name in this sector that rates a closer look is Bridgepoint Education (BPI), a debt-free business trading at 7x earnings. The "cheapness" of education stocks is directly attributed to the cloudy growth picture as enrollment growth is coming to a quick grind. Another consideration is that many of the names are heavily shorted, as some investors feel that default rates are going to surge dramatically. If that doesn't happen, short covering will provide another lift.
Whatever stocks you choose, the key consideration is to make investments for the right reasons and buy each stock at an attractive price. Trading on hope and fear is sure to guarantee more pain than pleasure.