Rising Star Trade: Cover Strayer Education

This article is part of our Rising Star Portfolios series. Follow all of Alex's trades on Twitter.

It's been scarcely six weeks since we initiated our for-profit education pairs trade, buying shares of Bridgepoint Education (NYSE: BPI  ) and shorting shares of Strayer Education (Nasdaq: STRA  ) . Bridgepoint is up 19%, while Strayer is down 19%, so we are making money on both sides of the trade. At today's prices, I'm no longer comfortable with the short side of our trade, so I'm going to -- pardon the boldface -- cover our short on Strayer Education and recommend that you do the same.

When we initiated our short on Strayer, the stock was priced for an unrealistically rosy future. In the initial trade alert, I wrote:

Strayer is priced for sunny days ahead. Today's price implies either 6% more students a year for a decade with today's recruiting costs, or 10% more students each year at industry-average marketing costs. Neither alternative is likely. When it comes to students, Strayer's already picked the low-hanging fruit. The company will have to either spend more to persuade prospects to pay its relatively high credit-hour prices, or settle for lower growth. Strayer isn't headed for the butcher's block, but I can't see the stock worth more than $125 a share, making today's $148 price quite rich.

At today's share price of $115, Strayer is now reasonably valued. As I wrote above, I don't believe this company is heading for the butcher's block. The risk-reward dynamic is no longer skewed in our favor, so I am going to lock in our profit on the short and move on.

What this means for Bridgepoint
With Strayer covered, the nature of our trade on Bridgepoint changes. Previously, we were betting that the valuations on Strayer and Bridgepoint would converge. In other words, we thought Strayer was overvalued and Bridgepoint was undervalued, and by shorting the former and buying the latter, we were making a bet on their valuations while removing the industry element. With our short on Strayer removed, we now have an unhedged directional bet on Bridgepoint.

Bridgepoint remains acutely undervalued. The company has been plagued by Congressional hearings, and, most recently, a subpoena from the New York attorney general. But even my most dire modeled scenario can't place a value on the shares below $29, and that can quickly turn into $39 in only moderate scenarios. Therefore, I am content with our now-unhedged position in Bridgepoint, and I might even consider adding to it once I more fully understand the subpoena situation.

Follow all of Alex's trades and market musings on Twitter.

Alex and The Motley Fool own shares of Bridgepoint Education. The Motley Fool is currently short shares of Strayer Education and, as per the article, intends to cover the position 24 hours after publication.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios) here.


Read/Post Comments (4) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 20, 2011, at 3:34 PM, moore34 wrote:

    I agree with you on BPI. In fact I have posted several posts on my blog trying to comment on issues that I have encountered while doing DD.

    Thanks for your time. Please check out my blog http://bit.ly/jrJO1O

  • Report this Comment On May 23, 2011, at 3:20 PM, yhtbfkm wrote:

    Nice call. Isn't it amazing when an entire fundamentally based thesis can come to pass in 6 weeks. One that focused on a company's growth profile over the next decade?

    The success of your trade had nothing to do with "Strayer's rosy future" (or lack thereof).

    You, like everyone short the space, rode the coattails of Harkin's Ready Fire Aim approach to regulation and a Department of Education (and GAO) all too willing to be his accomplice.

    Like I said, nice call.

  • Report this Comment On May 23, 2011, at 6:31 PM, XMFPapester wrote:

    yhtbkfm,

    Thanks. Shows again the importance of valuation - even with Harkin's actions, BPI is up about 20% in the same time frame. All else equal (and it never is), overvalued stocks have further to fall than undervalued ones.

    Cheers,

    Alex

  • Report this Comment On June 02, 2011, at 10:57 AM, yhtbfkm wrote:

    You'll notice I had no qualms with your long BPI call. It took a lot of nerve to buy the stock that was specifically targeted by Harkin in one of his sham hearings.

    On the other hand, claiming the success of the short call on STRA was due to anything other than being aligned with a politically motivated witch hunt was, of course, nonsense.

    All's well that ends well, I guess. I made plenty of money long STRA and APOL (taking advantage of analysis like yours that panicked other holders), while you made money long and short (which is a tough thing to do).

    If I were you, I'd avoid being complacent with BPI.

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