Education Stocks Are Setting Up For A Short Selling Opportunity

| January 11, 2012 | 0 Comments

It’s not every day that I talk about shorting stock.

But today, I’m making an exception.  You see, I’ve made a bunch of money over the years selling stock short.  And I think we can make a lot of money in 2012 with this strategy.

The stock market volatility we saw in 2011 will likely continue through 2012.  This means we should have plenty of opportunities to make money on the short side this year.

Before I tell you which stock I’m looking at shorting now, here’s a little reminder of how shorting works…

Shorting stock is an investing approach where instead of buying stock, you’re selling stock you don’t own.  Your broker essentially lends you a certain amount of shares to sell.  As soon as they do, you take those shares and sell them at the current market price.

The reason for using this approach is simple… you’re expecting the shares to decrease in value.

When they do, you simply buy the shares back at the lower price.  The difference between your selling price and the price paid to buy them back is your profit.

So, what stock am I shorting now?

Good short candidates are stocks that are overvalued or have a poor business outlook.  Obviously, these stocks are more likely to head lower in the short-term.

One stock I’ve made money shorting over the years is Apollo Group (APOL).  I’ll keep shorting this one until someone proves to me the ancient Mayans are wrong about the end of the world.

Here’s why… APOL is a company in a very tough business with poor prospects.

You see, APOL started in 1995 with an extremely successful IPO.  Since then, Apollo Group has seen tremendous growth.  Revenues exploded from the late 1990s all the way into the mid 2000s.  And the stock price followed suit, up some 900% during that same period.

And what was the reason for Apollo’s explosive success?

It came with the help of the federal government.  During this period of economic growth, the government made it unbelievably easy for companies like Apollo to make money.  By offering potential and new students attractive student loan terms backed by federal guarantees, enrollments in APOL soared to record highs.  This went on for years as the government kept the floodgates open and allowed students to borrow more.

But, I believe this is coming to an end.

The for-profit education industry has recently been described by several fund managers as one of the worst in the nation.  In fact, top hedge fund manager, Steve Eisman, recently came out as one of the most critical of the industry.

He points to the rising number of student loan defaults as well as sky high student dropout rates at these schools.

Now, Apollo is the industry leader in for-profit education.  But again, most of their success has been due to the wide availability of federal student loans.  A whopping 86% of APOL’s students use the program.

But the days of easy access to federally funded student loans are over.  New regulations regarding repayment rates and terms of student loans will start taking effect this year.

These new regulations will make it harder for Apollo students to get loans.  In order to qualify for federal loans going forward, APOL must meet new stringent requirements.  At least 35% of APOL’s former students must be actively paying down their loans.  And former students must be spending less than 12% of their total income and under 30% of their discretionary income on loan repayments.

As you might expect, total student enrollments in Apollo’s University of Phoenix degree programs have dropped by 15% year over year.  A trend that will likely continue for years to come.

Another reason APOL is poised for a fall… stock valuation.

It’s hard to see how APOL deserves a $56 share price.

APOL’s currently trading at 17x the 2012 earnings forecast of $2.80 per share.  This is a huge premium compared to its peers.  And with enrollments dropping like a stone, APOL isn’t likely to maintain such a high P/E going forward.

In fact, APOL probably doesn’t deserve a P/E higher than the industry average of 12.5x.  At that level, the stock would be worth no more than $35 a share.

Clearly, shorting this stock can yield huge profits…

Let’s say you borrow 100 shares from your broker and sell them at the current price of $56.  You immediately receive $5,600 into your account.  If APOL trades down to $35 per share as I expect, you’d buy the 100 shares back for just $3,500.

Your profit on the trade would be $2,100 ($5,600-$3,500).  In other words, you’d have made a solid 38% gain on a stock that dropped in value!  Not too shabby.

Bottom line…

There are a lot of overvalued stocks in the market with poor business outlooks.  Take advantage of these opportunities by using a short selling strategy to capture profits when these stocks drop in value.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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