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Why Chinese Education Stocks Bounced Back Today

By Rich Smith – Jul 27, 2021 at 12:26PM

Key Points

  • Rumors of a regulatory crackdown on education stocks have been building for months.
  • Today, both shoes dropped at once, crushing education stocks under their weight.
  • For-profit educators' tutoring businesses will now become nonprofit organizations.

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Sell the rumor, buy the news?

What happened

"Buy the rumor, sell the news" goes the old investing maxim, advising investors to buy stocks before they announce anticipated good news and then cash in when the news comes out. But...what do you do when the anticipated news is bad instead of good?

Well, it seems the answer today is to sell on the rumor of impending disaster and then buy back when the rumor proves true -- and that's how investors are reacting to confirmation of China's crackdown on for-profit education companies, as shares of

  • Gaotu Techedu (GOTU 6.60%) rose 4.6%;
  • New Oriental Education(EDU 7.88%) jumped 5.5%;
  • TAL Education (TAL 3.59%) went up 6%;
  • and 17 Education & Technology Group (YQ 7.43%) outpaced them all, exploding 22.1% higher.
Chinese dragon superimposed on a stock chart

Image source: Getty Images.

So what

This might not be the reaction you were expecting to today's news from Wall Street, where investment bank Daiwa downgraded shares of both New Oriental Education and TAL Education to "hold" today and Deutsche Bank did the same to New Oriental, TAL, and Gaotu Techedu.

As Deutsche explains in a note covered by TheFly.com, the Chinese State Council has just published its "Opinions on Further Alleviating the Burden of Homework and After-School Tutoring for Students in Compulsory Education," and the news is actually even worse than feared. After-school tutoring institutions such as Gaotu, New Oriental, TAL, and 17 Education must now transform themselves into "nonprofit organizations," with the aim of lowering the cost of education for students and their parents (and, incidentally, making it easier for them to contemplate having more kids, thus replenishing China's shrinking population).

Now what

New Oriental Education, TAL, and the others are going to have to become "nonprofit organizations"? That doesn't sound very promising for their, er, profits going forward, and it's a good reason Deutsche, for example, took today as a cue to replace its $20.10 price target on New Oriental stock with a target of $2.50, cut its target for TAL nearly 90%, from $85 to $8.60, and slap a $3 price target on Gaotu Techedu -- which Deutsche had previously valued at $97!

That being said, the worst has now happened, and the bad news is now baked into these companies' stock prices. It would appear that what we're seeing today is short-sellers closing their short positions and counting their winnings. This trading action is driving share prices higher in the short term, but beware: It could be a dead cat bounce.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends New Oriental Education & Technology Group and TAL Education Group. The Motley Fool has a disclosure policy.

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Stocks Mentioned

New Oriental Education & Technology Group Stock Quote
New Oriental Education & Technology Group
EDU
$26.97 (7.88%) $1.97
TAL Education Group Stock Quote
TAL Education Group
TAL
$5.77 (3.59%) $0.20
Gaotu Techedu Inc. Stock Quote
Gaotu Techedu Inc.
GOTU
$1.13 (6.60%) $0.07
17 Education & Technology Group Inc. Stock Quote
17 Education & Technology Group Inc.
YQ
$1.04 (7.43%) $0.07

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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