Here’s one from the financial textbooks. What makes a company’s share price fall more than 15 percent in one stroke, as Pearson’s did on Oct. 21? It’s usually either that investors think earnings will be lower than they expected, or that future growth will disappoint. In the educational publisher’s case, it is probably both.
Pearson’s stock fell sharply based on what doesn’t appear to be a big profit warning. It said its sales of the Financial Times and the Economist Group would reduce earnings per share this year by two pence, while exchange rates would cut another three pence. Pearson expects earnings to come in at the bottom of a reduced 70 to 75 pence range.
Current consensus was already just under 75 pence, though. So why the sharp fall? A lower expected tax rate is one reason, as it suggests the underlying drop in earnings is higher than it looks. Underlying revenue fell 4 percent in the third quarter, despite the fact that Pearson said it continues to gain market share across its major markets.
This does not bode well for growth this year or next. Pearson admits that factors that have persisted “for some years have yet to improve”. The main problems seem to be in Pearson’s North American business, its biggest market. Pearson was hit by lower community college enrolments in the United States and higher textbook returns. South Africa also bought fewer textbooks.
The U.S. college issue does seem cyclical: fewer students sign up to vocational community colleges in buoyant job markets. Though the United States has a growing high-school population, it’s unclear when enrolments will pick up. Pearson also faces ongoing challenges in its U.S. testing business and the political backlash surrounding the Common Core curriculum in the United States, which lays out the basic things students should know at the end of each grade.
The disappointing lack of clarity on growth explains why investors have de-rated the stock. After the slump, it is trading on just over 14 times this year’s expected earnings, against about 16 before the warning. Pearson has cautioned on profit in past years, but now a glum present has come with a glum future. Regaining confidence will be a test.