This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Quick! Name a "China stock"!
Let me guess -- you probably said Baidu.com (Nasdaq: BIDU  ) , right? Or perhaps NetEase.com (Nasdaq: NTES  ) , Sohu.com (Nasdaq: SOHU  ) , or SINA (Nasdaq: SINA  ) ? They're all fine companies, I suppose. Capital-light, Internet-focused business models. Fast, Internet-speed growth rates. But according to Nomura Securities, there's one company in China that deserves your attention. A company that's cheaper than Baidu or SINA, and will likely grow faster than either Sohu or NetEase. Its name is New Oriental Education (NYSE: EDU  ) , and it's the subject of today's column. 

As you may have heard, New Oriental reported its fiscal first-quarter results last week, scoring an "earnings beat" with profits a penny ahead of estimates, and growing student enrollments nearly 15%. At last report, the company had well over 800,000 students enrolled at its schools, and it expects to collect as much as $129 million in revenue from them this current quarter -- 34% better than last year.

That's considerably better than even the 30% long-term earnings growth rate that most analysts on Wall Street expect out of New Oriental. And to Nomura, it's a great reason to own the stock today: "We ... find that the growth story has strengthened. Critically, the product mix change with increased focus on K-12 underpins our upward revisions to revenue and earnings forecasts. ... with nearly 20% upside potential, we upgrade the stock to Buy."

Hold up a sec. Did you say "strengthened"? As in "better"?
Yes, you read that right. Oh, I know that many investors were disappointed with New Oriental's report last week. The stock actually sold off by 12% when the news came out. But for the life of me, I don't know why -- Nomura is exactly right about the improvement. In addition to growing its number of enrolled students by 15%, you see, and in addition to growing revenues 41%, New Oriental also improved the profits it wrung from those revenues.

Gross margins improved by 40 basis points (that's 0.4% to you and me). Operating margins were up 50 bp. The net profit margin increased by a cool 100 basis points, or one full percentage point, as New Oriental converted $0.33 out of every revenue dollar into bottom-line profit. (Apropos of everything, of the more famous "Chinese stocks" named above, only Baidu managed to improve all of its profit margins at a faster clip than did New Oriental, while SINA and Sohu saw all of their margins shrink, and NetEase saw similar drops in gross and operating margins.)

Foolish final thought
Investors who brave the well-publicized risks of Chinese stocks are, as a general rule, motivated by the fast growth rates common among Chinese companies. And I suppose it goes without saying that even a company with 800,000 students on the books has a lot of room for growth in a population that stretches past 1.3 billion ... but I'll say it anyway.

New Oriental Education's 30% projected long-term growth rate exceeds that of the average Dow Jones Industrial Average (INDEX: ^DJI) stock by a factor of three. It's growing nearly five times as fast as the U.S. for-profit education flagship, Apollo Group (Nasdaq: APOL  ) . But with its revenues rising in the 30%-and-up range, and profit margins expanding strongly, I see every possibility for New Oriental Education to live up entirely to its prospects. At a valuation of 34 times earnings today, and an enterprise value-to-free cash flow ratio of just 22, this stock gets a "buy" from Normura -- and I agree.

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