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This Industry Has a Failing Report Card

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The for-profit education industry has attracted some serious public relations problems these days -- not to mention regulatory scrutiny. However, this industry's report card fails on many levels, making it a segment I can't recommend investing in.

News headlines about for-profit educators have probably made you at least remotely aware of the serious social ramifications that are involved -- ramifications that we all end up paying for, one way or another. If that's not enough danger, real bottom-line financial risks loom for these companies, too.

Supposedly "cheap" valuations and negative sentiment surrounding the industry may tempt some investors to buy the stocks. Don't grade these companies on a curve; that could result in a hard lesson in failed investments.

For-profit education and American debt
GMI, which provides global corporate governance and environmental, social, and governance research -- or ESG -- has released a report on the for-profit education industry's high-risk position in the marketplace.

Right off the bat, the report reveals some troubling facts concerning the industry. The group overall tends to produce low graduation rates. Add in this sobering element of our overly indebted nation: Student loans currently represent a greater amount than American consumer credit card borrowing, and nearly half of all student loan defaults emanate from for-profit education's borrowers.

Although some laud the for-profit education industry as a free-market approach to education, here's a factor that contradicts free market arguments: some of these companies rely quite heavily on government programs and funds. GMI pointed out that for some, Federal Title IV student aid funding represents as much as 89% of their revenue source.

Three major failures
Three of the four companies GMI covered are considered to have a high degree of fiduciary risk, receiving the lowest ESG rating GMI doles out. The list included Apollo Group (Nasdaq: APOL  ) , the company behind a far more recognizable moniker: University of Phoenix. Education Management Corp. (Nasdaq: EDMC  ) and Corinthian College (Nasdaq: COCO  ) also earned GMI's worst rating.

Corporate governance-related red flags shared by all three include concerns about directors' industry expertise, the ratio of CEO equity to CEO base salary, and incentive pay that's poorly linked to outperforming peers. The report highlights other corporate governance-related red flags, too, such as Apollo's and Education Management's related party transactions involving management or the chairman, as well as their restrictions on shareholder voting rights.

Washington Post (NYSE: WPO  ) was reported as the least risky company of the four examined. Although its Kaplan subsidiary contributes more sales to the company than its better-known newspaper business, GMI found that its relative absence of corporate governance or accounting concerns and its more diversified revenue alleviates its riskiness.

Like school in summer -- no class
If the previous arguments aren't convincing enough, let's talk about the elements that are poised to hit the for-profit education segment straight in the pocketbook.

Federal and state probes of these companies' use of public funding and high student loan default rates have gotten plenty of attention. The specific issues involved should chill investors.

For example, the Department of Justice filed a fraud suit against Education Management earlier this year. Education Management has been accused of not being eligible for any of the state and federal financial aid it received from mid-2003 to June of this year, or more than $11 billion, which is only slightly less than the company's total revenue over the eight-year period. Under the False Claims Act, it could be subject to triple damages, or $33 billion.

GMI points out that even though "negative externalities" -- costs that society pays for, as opposed to the corporate behavior that caused the costs -- are usually associated with industries like the tobacco industry, or big corporate polluters.

However, similar concepts are at work with these companies, which seem to be churning out more bad debt than highly skilled workers. And these days, more people are aware that responsible corporations must foot the bill for big costs to society.

Risk Avoidance 101
Although GMI's research focused on just the four companies mentioned above, I wouldn't touch shares of Strayer (Nasdaq: STRA  ) , DeVry (NYSE: DV  ) , Bridgepoint Education (NYSE: BPI  ) or any of the other for-profit education companies right now, either. (Note that several of my Foolish colleagues involved in Rising Stars and in several of our premium services have bought or recommended Bridgepoint. While I respect their opinions on that stock, we're a motley bunch here at The Motley Fool, and I simply can't consider industries or companies that are teeming with this kind of risk.)

The reputational risk facing the for-profit education industry boils down to an extremely unpleasant factor. It too often capitalizes off of the poor economy and many Americans' desperate attempts to improve their lot in an extremely challenging job market. I'm all for trying to improve one's financial standing in the world and expand skills, but too many folks are taking on huge piles of untenable debt that they can't afford, for an end result that likely won't result in well-paying jobs (or even the ability to pay off the obligations).

The for-profit education industry profits off that desperation, and doesn't appear to be doing much to help the marketplace or the American economy at large. That's a lesson in trouble for all of us.  

Check back at every Wednesday and Friday for Alyce Lomax's columns on environmental, social, and governance issues.

Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Bridgepoint Education. Motley Fool newsletter services have recommended writing puts on Bridgepoint Education. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 18, 2011, at 3:59 PM, stockton32 wrote:

    As a graduate of Everest University, a Corinthian school, I can say that they did an excellent job providing a quality education at an affordable price. For a private school, they were frankly the most reasonably priced tuition in the area I live in! Not only that, after transferring from the community college and another well known state school, I was very surprised at the knowledge and experience of each of my instructors (much better hands-on approach to learning than the public schools, overall). Thanks to them, I was able to land a job immediately following attainment of my degree. As a manager now, I work with the Career Development office at Everest in hiring an occasional new graduate and have yet to be disappointed in the quality of student they are putting out. Now, I do remember having some students drop out during my program, but it certainly wasn't the fault of the school. Anytime I missed class, I was contacted by my instructor to make sure I received the assignment and knew what to be prepared for at the next class session. There was a sincere attempt to get me, and each of my classmates to graduation, and eventual employment. Your article doesn't ring true about my school and the predatory picture you're trying to paint about them.

  • Report this Comment On November 19, 2011, at 12:40 AM, rodnog wrote:

    Bookiekiller... I hate to be an passive aggressive grammar fan, but perhaps you could go to one of these schools and learn about punctuation?

  • Report this Comment On November 19, 2011, at 12:40 AM, rodnog wrote:

    Oh and would you look at that, i went and screwed up my grammar! That'll teach me...

  • Report this Comment On November 22, 2011, at 11:17 AM, DJDynamicNC wrote:

    @Stockton - I see why you would feel compelled to defend your employer, but you must remember (and may or may not have been taught) that anecdotal evidence cannot provide the sort of accurate picture of affairs that statistical analysis can. Try this:

    "I live in North Korea, and I've never been purged by Kim Jong Il's government. I've always done exactly what Dear Leader told me to do, and I've succeeded well. Now I work in the Ministry of Truth for our Dear Leader. The picture that Western news media paints about mass killings and human rights violations simply doesn't ring true in my experience."

    in other words - "it didn't happen to me" is not the same as "it didn't happen."

    It would be just as easy to provide an anecdote about how bad for-profit schools have been for my aunt, but that would prove as little as your claims. The best way to get a sense of the industry is to look at the industry as a whole, and in the case of this particular industry, the market has created a deeply flawed product for a variety of reasons. I am glad your experience differs from the average, but please be aware that it differs from the average.

  • Report this Comment On November 25, 2011, at 5:19 PM, DJDynamicNC wrote:

    For a look at how for-profit educational companies stack the deck in their favour to take your tax dollars and line their pockets, check out this:

  • Report this Comment On November 25, 2011, at 10:38 PM, grain wrote:

    @DJDynamicNC: I did take a look, and the blog you linked is not talking about the same group of companies as this Fool article. The blog is talking about K-12 charter schools and voucher programs. The Nation article that the blog builds from makes this clearer:

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