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ESI: Extra Strong Income

I'm beginning to wonder whether ITT Educational Services (NYSE: ESI  ) should perhaps just bite the bullet, reach into its copious bank account, and haul out the big bucks necessary to put Johnnie Cochran on retainer. Whatever it takes to follow Corinthian Colleges (Nasdaq: COCO  ) through that happy door of regulatory exoneration. Truthfully, if not for the fact that ITT remains a target of federal investigation, why, everything would be going just swimmingly for this company, and its investors could resume dreaming of retiring to little pink houses with white picket fences out in Californ-i-a. (Or, as I put it three months ago: "Allegations of massive fraud aside, ITT looks good.")

In its earnings report for fiscal 2004, ITT reported a whole passel of good news, most of which was marked with asterisks and/or footnotes advising investors of how much better things would have been were it not for the danged lawyers and their insatiable appetite for billable hours.

But even with the legal fees racked up fending off everyone from the FBI to the class action trial lawyers, ITT didn't do half bad. For the year, revenues increased 18% over 2003's numbers; operating income rose 26%, and net profits grew 28%. 1.1% worth of annual stock dilution knocked about a percent off of the diluted profits per share increase, but that still left shareholders with $1.61 in profits. At that level, if we assume that legal eagles will continue to dog the company (how's that for a mixed metaphor?) ad infinitum, ITT shares currently trade for about a 29 P/E ratio, giving it roughly a 1.1 PEG. So it's pretty fairly priced according to standard valuation methods.

From a free cash flow perspective, things don't look quite as strong. Free cash flow declined year on year, falling from $112 million to $101 million. But the company was able to sock that cash away and saw its cash and equivalents rise by about $100 million over the course of the year, leaving ITT with $357 million by year-end.

Despite the lower level of cash generation, given its cheap valuation, ITT looks pretty attractively priced at an enterprise value-to-free cash flow ratio of about 18 -- considerably cheaper than the company looks on a P/E basis. Now, if only it can get its free cash flow growing again at the same rate its GAAP earnings are rising, the company might start looking like a "buy" to this Fool.

Assuming, of course, Johnnie can straighten things out with the Feds.

Read up on ITT's legal travails in:

Fool contributor Rich Smith owns no interest in any of the companies mentioned in this article.

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