Here's what an advisory letter said today;"One of our companies reported earnings and the announcement caused the stock to move significantly today. I know that many of you are wondering if now is the time to sell your position so I wanted to get in touch with you to discuss what happened and tell you what to do now. New Oriental Education (NYSE: EDU) reported Q2 earnings last night and the stock sold off 21.8% in response to the report. New Oriental is one of our big winners, and even including today's sharp sell-off, is still up 150% for us since I first recommended it in October 2006. Here are the highlights of the report: Total revenues were up 42% to 240.6 million yuan ($32.6 million) from 169 million yuan a year ago, higher than Wall Street consensus estimate of $30.7 million. Net income up 77% to 14.5 million yuan ($2 million) from 8.2 million yuan a year ago. EPS was 5 cents, flat from a year ago, as a result of share based employee compensation. Excluding share-based compensation (which was high because the stock did so well), operating earnings was 10 cents per share, up 100% from a year ago. Student enrollments were up 18.5% to 257,700 from 217,500 a year ago.At first glance these numbers look strong, yet investors responded negatively to the news. So what caused the big sell-off? There were several factors that impacted this quarter's earnings. The first problem in this report was higher share-based compensation expenses (i.e. stock options). The share-based compensation expenses were high because the stock appreciated so much last year. These are payouts based on how high the stock price climbs. Basically, the higher the share price, the higher the payout that executives and employees receive. If we take out these expenses, the operating margin for the quarter was 5.8%, higher than 4.9% in the same period last year. The second problem is that prior to heavy-enrollment periods, marketing expenses always go up for EDU. In this quarter there was a 50% increase in marketing expenses as the company gears up for the typically strong winter period as students load up on tutors during their winter break. Going forward, as is typical for New Oriental, marketing expenses will probably decline during the next reported quarter so I'm not worried about this aspect of the report. Many investors and analysts don't seem to understand that New Oriental is in a seasonal business. The just-reported October- December quarter is always the weakest quarter for the company. As I mentioned, Chinese parents tend to send kids to test prep classes during winter break in late January/ early February and summer vacation from July through September. This can be seen in the company's earnings reports. For instance, the most recent EPS for Q1, which covers the summer months, was $0.87 a share compared to only $0.05 a share for this past quarter. Looking ahead, New Oriental expects its total net revenues in the second quarter of its fiscal year 2008 to be in the range of $28.0 million to $29.8 million. That represents about 30% growth from the most recent quarter and an overall 25% to 30% growth from last year. After a closer look at the numbers, I believe that EDU management is making the right decisions and is placing its marketing costs at the correct times. I still like the stock as a long-term play on China's education sector and I believe that the 21.8% hit the stock took today was overdone. Take this opportunity to buy EDU below our new buy limit of $65. "I got in @ $63.24 in after hours trading. My original shares bot @ $25.04 on 11/1/06 are still more than a double.
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