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3 Reasons to Buy Chegg Before It Reports Earnings

By Parkev Tatevosian, CFA – Oct 17, 2020 at 7:40AM

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The coronavirus induced campus shutdowns are leaving a void in resources that students need.

The coronavirus pandemic has led colleges and universities to convert most of their classes into online courses. The change has left students responsible for learning the same amount of material as before the pandemic, but with less access to vital resources. 

Enter Chegg (CHGG -0.53%), the leading direct-to-student platform that provides additional help in many subject areas. As a result of increasing online courses, the company is experiencing surging user engagement and subscriber growth. The company reports third-quarter earnings on Oct 26. Here are three reasons to buy the stock before that.

A student sitting at a desk with a laptop taking notes.

The coronavirus pandemic is leading schools to move classes online. Image source: Getty images.

1. Robust revenue growth

The first reason to buy Chegg is accelerating revenue growth. In the previous two years, the company grew revenue by 26% and 28%, respectively. That figure is on pace to be much higher this year, with revenue thus far up 49% from the prior year. Once they decide to deliver courses online, colleges and universities are unlikely to shift back to in-classroom learning in the middle of the term.

With coronavirus cases surging in several regions of the world, the pandemic's end is not imminent. That means for the winter and spring sessions of 2021, many schools will continue with remote learning. In fact, the California State University system, the largest in the U.S. with over 480,000 students across 23 campuses, has already announced the spring term will be online. More classes going online means less one-on-one time for students with professors and less access to important campus resources such as tutoring, writing centers, and library materials. Needham analyst Ryan MacDonald stated:

We recently conducted our Fall 2020 Student Survey to gauge digital study tool usage trends at universities across the country. Our survey of more than 580 students indicates that demand for digital study tools in a remote learning environment has increased, with 61% of respondents more likely to use digital tools. The number of digital tools used is also expanding as, on average, 31% of respondents are using 3 or more tools this fall, up from 17% pre-COVID. We believe these trends will benefit Chegg heading into [the second half of 2020 and the full year 2021] as the solution remains one of the top 3 most commonly used by students."

2. It's keeping costs under control

A second reason to buy Chegg is that it's growing revenue much faster than expenses. As a percentage of overall revenue, total operating expenses decreased from 71% in the previous year to 57% in the most recent quarter.  Moreover, EBITDA margin has increased from negative 1.3% to 5.3%, to 11.7% in 2017, 2018, and 2019, respectively. As the business scales up and revenue continues to expand, profit margins are going to increase. 

3. The runway extends beyond the pandemic

Lastly, Chegg has growth opportunities even after the pandemic has run its course. One specific opportunity is international expansion. Of the $4 million increase in marketing spending for Chegg in the most recent quarter, $2.3 million was for international markets. Another opportunity is in technology that will allow the company to reduce account sharing among students.

Moreover, the long-run trend is toward increased courses and assignments offered online. Students appreciate the flexibility that online courses offer, and schools can offer classes to more students while using fewer valuable resources. Classrooms are typically limited to between 25 to 50 seats, whereas an online course can register much more.

And when classes go online, students have fewer opportunities to ask questions of professors. This is where Chegg can help fill the void. Subscribers, as part of their membership, have the ability to ask questions and have them answered by subject matter experts on Chegg.

A scenario where 100% of courses are online is unlikely. But it will not be surprising if an increasing percentage of instruction is moved online. 

A woman studying at a desk with a computer and a notepad.

Image source: Getty images.

What this means for investors

The market seems to agree that prospects for Chegg are excellent. The stock is up over 120% year to date. It's now selling at a price-to-sales ratio of 21, which is the highest it's ever traded. Still, given the high probability that the company will report robust revenue growth for at least the next two quarters, and the long-run tailwind of instruction moving increasingly online, the company provides good value for long-term investors. That, along with the growth opportunities for international expansion, reduced account sharing, and additional offerings, could lead Chegg to grow into its valuation.

It will be prudent for those interested in this consumer discretionary stock to buy at least some portion of their desired allocation before the company reports earnings on Oct. 26. The stock could rally if the company reports excellent earnings and gives optimistic forecasts. 

Parkev Tatevosian has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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