New Oriental Education Schools the Market

Editors' note: An earlier version of this story incorrectly stated that TAL is under an SEC investigation. The Fool regrets the error.

There are one-hit wonders, and then there are those stocks for which the initial big move is only a preview for even bigger and better gains to come.

Chinese test-prep provider New Oriental Education (NYSE: EDU ) jumped 25% over the past month, far surpassing the 2.4% gain by the broad market index. As an SEC investigation moves forward, analysts think there is the possibility it's got potential for even greater gains.

New Oriental Education snapshot

Market Cap $640 million
Revenues, TTM $772 million
1-Yr. Stock Return 31.6%
Return on Investment 21.0%
Est. 5-Yr. EPS Growth 20.8%
Dividend & Yield N/A
Recent Price $16.67
CAPS Rating *

Source: FinViz.com. N/A = not available; EDU does not pay a dividend.

A mighty temblor
The test-prep specialist saw shares tumble in July after short-selling outfit Muddy Waters, which has targeted a number of fraudulent Chinese shops, said its business operations were not what they said they were. Contrary to management's assertions, New Oriental has a franchise structure that operates for the profit of insiders and to the detriment of shareholders.

That happened just the day after New Oriental said the SEC was investigating it over whether there is a sufficient basis for the consolidation of Beijing New Oriental Education & Technology (Group) Co., a variable interest entity of the parent and its wholly owned subsidiaries, into its consolidated financial statements. That's the entity Muddy Waters accused of being a fraud. The stock lost more than 50% of its value with the one-two punches.

Although there hasn't been any further allegations or developments out of New Oriental, industry rival Ambow Education (Nasdaq: AMBO ) was recently accused of exaggerating staff training results, and the school's registrations with regulators were incomplete. This wasn't a short seller making the charge, but rather China's state television, and it lost half its value. TAL Education was contacted by the NYSE after it noted unusual activity in its stock; it lost a third of its value.

Getting left back
It wasn't just Chinese educators under the gun -- and microscope. Bridgepoint Education (NYSE: BPI ) became the subject of numerous class action lawsuits after it was denied accreditation amid various operational failures. Its stock lost two-thirds of its value. These are different issues than those facing for-profit educators like Corinthian College (Nasdaq: COCO ) and Apollo Group (Nasdaq: APOL ) , though the stock charts look similar.

Unlike many of its peers, New Oriental is mounting a comeback. The stock has risen 77% from the lows it hit after the SEC-Muddy Waters tag team smackdown. Partially that's a result of management answering at least some of the charges the short sellers leveled, and apparently cooperating with the SEC in its investigation. It could be that the worst that comes out of this episode is that New Oriental has to restate its financials, which in itself would be another blow, though perhaps only temporary. One analyst said it could jump as much as 60% upon an otherwise favorable conclusion of the investigation.

Going to the head of the class?
Even with China's economy coming in for a hard landing, the middle class is growing and money is still percolating up through society. With many Chinese students looking to gain admission to notable American universities, tutoring services remain a burgeoning market. New Oriental Education, and to a lesser extent its rivals like TAL and Ambow, will find demand for its affordable K-12 tutoring services.

At 12 times earnings it seems cheap, and with its enterprise value trading at just 10 times free cash flow, New Oriental looks like it's trading at a discount. But, with the potential for a restatement lurking on the horizon, it's hard to have any confidence in the numbers it's reported at the moment. I'll be passing from making a CAPSCall on the educator, but share your view in the comments box below on whether New Oriental Education will be able to graduate back to the big leagues, or whether an investor would be a dunce for buying in at this time.

Shake, rattle, and roll
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