Chegg (CHGG 0.34%) is one of the leading players in the education technology market. The company offers course curriculum help primarily to college students worldwide. Its services are becoming increasingly sought after as more learning is happening online.
The trend may reverse somewhat as it relates to the economic effect of COVID-19 and economies reopen, schools resume in-person classes, and more of the population gets vaccinated. But Chegg's services are not so tied into online learning and are used for offline courses as well.
Let's look closer at Chegg's business to determine if the stock is a buy right now.
Chegg boasts a strong competitive advantage
Chegg has a business model that is built on a sound foundation. The company creates proprietary content that attracts subscribers through search engine results at little cost. Further, the content is created once and has the potential to serve students for decades. Its content consists of step-by-step examples of how to solve problems students encounter in their college courses.
The evidence of the profitability of this model is demonstrated in the company's strong free cash flow growth from roughly $25 million in 2017 to $149 million in 2021.
Moreover, that content library its building is creating a competitive moat around its business. The company now boasts 66 million pieces of educational data, having added 7 million in the most recent quarter alone. Importantly, this content is created as students encounter difficulties in their studies. As part of a subscription to Chegg, each student can ask 20 questions per month that Chegg pays experts to answer. The content is unique and will be very difficult for competitors to duplicate. And if they do attempt to reproduce it, it could take years for them to reach the quantity that Chegg has.
For 2020, Chegg had 6.2 million services subscribers, which is a reasonable size of the market. Chegg estimates there are 102 million students worldwide that can benefit from its services. Even though it has made solid progress so far, it looks like it has several years' worth of room for growth. According to a company survey, users of its services gave it a high score among several metrics aimed to measure learning outcomes. Good ratings from existing customers could be an indication that new members will find its services helpful as well.
Is Chegg's stock expensive?
When you look at Chegg's price-to-free cash flow ratio and its forward price-to-earnings ratio (see chart), the data would suggest the stock is not expensive. The company is trading at a price-to-free cash flow ratio of 62, near the lower range it has sold at in five years. Moreover, Chegg is trading at a forward price-to-earnings ratio of 45, which is a reasonable price for a company growing sales and profits as quickly as Chegg.
The favorable pricing results from Chegg increasing cash flows and earnings while its stock price is falling. As of this writing, Chegg's stock price is down 24% year to date because of investor concern about how it will perform as students return to campus. That's created an opportunity for long-term investors to buy Chegg's stock at a reasonable price.