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ITT: Risky, But Cheap

For-profit educator ITT Educational Services (NYSE: ESI  ) has had a rough time of it ever since federal agents raided its headquarters and 10 branch campuses back in February. On Monday, the company's president and COO resigned without explanation. It almost goes without saying that the company's stock price has suffered -- 44% off its 52-week high.

By now, few companies better fit the "unloved" moniker of a potential hidden gem, than does ITT. Yet the company has still not been charged with committing any crime! Granted, it would be imprudent to ignore the risks of investing in a company that could, at any moment, be hit with a range of fines, administrative penalties and court verdicts from the Justice Department, SEC, Department of Education, and a couple of dozen plaintiffs' law firms. But what if ITT is found innocent on all, as-yet-uncharged, charges? Could ITT be a diamond, lying in the muck of public scorn, waiting to be picked up and polished to gleaming? Let's run the company through our 7 Steps to developing a rough picture of a company's investment potential and find out.

Market cap
With a $1.6 billion market cap, ITT is a quintessential small cap.

Enterprise value-to-free cash flow
ITT just misses my admittedly stingy standard of having an enterprise value-to-free cash flow ratio under 10. Its $1.3 billion EV, divided by its $121 million in trailing free cash flow, is close, however, at 10.7.

Historical and projected earnings growth
Like for-profit educational peers Corinthian Colleges (Nasdaq: COCO  ) , Career Education (Nasdaq: CECO  ) , Strayer (Nasdaq: STRA  ) , University of Phoenix (Nasdaq: UOPX  ) , and Apollo Group (Nasdaq: APOL  ) , ITT has a history of strong earnings growth (24% per annum over the past five years) and enjoys bright prospects for the future (20%).

ITT's EV/FCF/G falls somewhere between 0.5 and 0.6. That's cheap by any measure (but remember there is good reason for this).

Return on equity
This one is hard to believe. ITT sports a return on equity of nearly 50%. Could you combine the ROE's of tech darlings Cisco, Microsoft and Intel (admittedly a meaningless exercise, but still), they would all still fall short of ITT's astronomical number.

Insider ownership
Insider ownership at ITT is a respectable 9%.

Share dilution
ITT has negative share dilution. In other words, with each passing year, it makes each shareholder's piece of the company pie grow bigger, not smaller.

Wall Street hates ITT. Class action law firms do, too. Even the U.S. government is showing a healthy dislike for the company. That said, if the myriad complaints, investigations, and lawsuits turn out to be just so much litigious sound and fury -- and it is hard to overemphasize the "iffiness" of that hypothesis -- the company's current price will be revealed as a real bargain.

Fool contributorRich Smithowns no shares in any of the companies mentioned in this article. The Fool has adisclosure policy.

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