Investors Flunk New Oriental Education

Grab your favorite red pen, and write a big, red "F" across the pop quiz investors took when they sold off shares of New Oriental Education (NYSE: EDU  ) yesterday. Apparently, we can't tell long (-term) division from short.

Before I progress with critiquing investors' reaction to the news, though, let's quickly review just what the quarter's news was:

  • New Oriental's fiscal Q2 2008 sales raced ahead 42.4% year over year, to $32.6 million.
  • Student enrollments increased 18.5% to approximately 257,700.
  • Fifteen new schools and "learning centers" were added.
  • Profits per American Depositary Share grew 68% to $0.05.
  • Free cash flow totaled $6.9 million -- nearly 3.5 times the company's GAAP earnings.

Where's the bad news?
What really seems to have spooked investors was not New Oriental's performance last quarter, but rather its prediction of just 22% to 28% sales growth in the current third quarter. That's a significant slowdown from the 51% growth posted in Q3 of last year, when New Oriental benefited from a long winter break in China. State school students took advantage of the longer break to sign up (and pay) for more "language-training and test-preparation courses" at New Oriental, boosting sales.

This Q3, in contrast, New Oriental expects to face headwinds because State schools are expected to shorten their winter breaks a week or more, extending students' summer breaks during the Beijing Olympics. The shorter winter break is expected to hit New Oriental's Q3 sales hard, curbing growth.

Foolish takeaway
So, to summarize, we're looking at a one-quarter slowdown because of factors entirely out of New Oriental's control, with apparently no effect whatsoever on the firm's long-term growth prospects. Does that really justify selling the stock off by 22%, as investors did on Tuesday, let alone the 34% drubbing New Oriental took before the shares started reviving?

Of course not.

That said, a Fool can't help noticing that even after the sell-off, New Oriental sells for 54 times trailing earnings, despite analysts' belief that it will grow at "only" 31% per year over the next half-decade. Using the PEG ratio, New Oriental is not quite as expensive as other Chinese stocks -- Yingli Green Energy (NYSE: YGE  ) or China Unicom (NYSE: CHU  ) , to name a couple. 

Though it still seems a mite pricey to me, it's a lower valuation than investors have awarded U.S. educators like Strayer (Nasdaq: STRA  ) or Apollo Group (Nasdaq: APOL  ) . (That might get worse for Apollo, if it winds up paying its latest $280 million jury verdict.) Then again, that may say more about the U.S. for-profit educators than it says about New Oriental.

What's new in the Orient? Read all about it:


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