Failing Grade for ITT?

Two weeks ago, federal agents raided the Indianapolis headquarters and 10 branch campuses of post-secondary technical educator ITT Educational Services (NYSE: ESI). No one seems to know what the Feds were looking for -- the company says it doesn't know, and the Department of Justice is keeping mum.

But ever since the raid, ITT's stock has been in freefall. By yesterday's close, it had dropped 39% from its $57.40 closing price on Feb. 24.

All this, despite no charges filed being against the company and a clear instruction by DOJ that "no conclusions should be drawn from yesterday's activities."

Yeah, right. No sooner had the raids taken place, trading in ITT's stock was halted. And when trading re-opened, investors dropped the stock like it was radioactive.

What's more, the stocks of most other for-profit educators fell along with ITT. You name it, the stock collapsed: Corinthian Colleges (Nasdaq: COCO), Apollo Group (Nasdaq: APOL), University of Phoenix Online (Nasdaq: UOPX), Sylvan Learning Systems (Nasdaq: SLVN), Strayer Education (Nasdaq: STRA), and DeVry (NYSE: DV).

Of course, of these six, only Sylvan's stock remains below its Feb. 24 price. All of the others quickly bounced back from their initial drops and have even climbed higher. (But then again, Sylvan also has the highest trailing P/E ratio of the bunch, at 374, and is also the only company that is free cash flow negative, so it was not in the strongest position to begin with.)

As for ITT's prospects, its CEO says that the government investigation could drag on. And since no one seems to know just what the Feds are seeking out -- or how damaging it will be to ITT if they find it -- it seems likely that ITT's price is going to be depressed for the foreseeable future.

Keep that in mind if you feel at all tempted by the company's currently low enterprise value-to-free cash flow ratio of 12. When a company is growing its revenues at 20% annually, yet has an EV/FCF ratio of nearly half that, it might be an undiscovered treasure, like the companies profiled every month in Motley Fool Hidden Gems. But with federal agents running around its corporate offices, and a lengthy government investigation ahead of it, ITT will more likely turn out to be a lodestone for any portfolio in which it sits.

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