The Pearson share price is rising: should I buy now?

The Pearson share price has been on an upward trend. Will it continue to rise? Royston Roche reviews the stock to see if it’s a good buy for his portfolio.

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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The Pearson (LSE: PSON) share price rose about 65% in the past year. Pearson is a learning company. It provides content, assessment, and digital services to learners, educational institutions, employers, governments, and other partners globally. Previously, in a bid to focus on the growing education sector, it sold its businesses like Financial Times and The Economist.

I would like to understand the pros and cons of investing in this FTSE 100 stock.

The bull case for the Pearson share price

Digital learning, workforce skill gaps, and demand for certification have created immense opportunities for the company. Pearson has also created a new direct-to-consumer group to cater to this strong demand. According to Global Market Insights, the e-learning market surpassed $250bn in the year 2020. It is now expected to grow at a CAGR (compound annual growth rate) of 21% between 2021 and 2027.

Pearson has a vast market opportunity due to its diversification. According to the company’s annual report, the expected size of the learning market will reach $7tn by 2030. Virtual learning, higher education, English language learning, workforce skills, and assessment and qualifications are the new divisions. Many prestigious schools in the UK, which used to offer online education to international students only, currently offer the same to British teenagers due to the Covid-19 pandemic. In my opinion, the pandemic has created opportunities for the online education market. The assessment segment is another growth area.

Pearson’s revenue in the first quarter grew by 5%. This is good despite the disruptions due to the Covid-19. The growth was primarily helped by the global online learning division that grew by 25%. It generates about 20% of the group’s revenue. The North American division also showed 1% growth, as it benefited from increased school funding and the continued sales shift to digital in Canada, offset by the US higher education decline.

The company has a stable balance sheet. It reported a free cash flow of £229m for the year 2020. The proceeds from the sale of the publishing business, Penguin Random House, also helped the company to reduce net debt to £463m at the end of December 2020 from £1.0bn for the previous year.

Risks 

The company has struggled with growth in the past few years. Revenue dropped from £4.6bn in 2016 to £3.4bn in 2020. Even though digital learning is expected to grow quickly, much of the company’s revenues are tied to physical learning. Also, if Covid-19 cases increase globally, the company’s revenue might continue to drop. This would be negative for Pearson’s share price.

The stock is currently trading at a price-to-earnings ratio (P/E) of 20.56. In my opinion, the shares are overvalued, as its five-year average P/E is 14.78. Similarly, the price-to-book ratio is 1.55, compared to its historical average of 1.31.

Final view

I like the company’s expertise in online learning and digital skills. Its cash flows are good. However, I feel that Pearson’s share price is overvalued at the current price. I will keep the stock on my watchlist, and I am not a stock buyer today.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Royston Roche has no position in any of the shares mentioned. The Motley Fool UK has recommended Pearson. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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