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ITT Educational Services Puts On the Dunce Cap

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Typically when companies forecast lower sales or profits, their stocks take a hit. It's not always easy to tell whether it's having a fire sale or burning down its house. Maybe it is time to get out -- or maybe it's time to buy more!

For-profit education provider ITT Educational Services (NASDAQOTH: ESINQ  ) got left back yet again after disappointing the markets with a fourth-quarter effort that saw lower enrollment amid greater scrutiny of industry marketing practices. Its outlook for 2013 earned a failing grade, too, forecasting per-share profits between $3.50 and $4.00, well below expectations of $4.66 per share. The stock has lost three-quarters of its value over past year as the toll of government investigations mounted.

Now, don't blindly follow those selling (or buying) on this apparent bearish signal: You still need to dig further. We'll just use the announcement as a jumping off point for additional research.

Like lemmings over the cliff
For-profit schools have been the target of critics for well over a decade because of high dropout rates, alleged misuse of federal monies, improper marketing tactics, and more. The animus against the industry grew under the Obama administration, with the Education Department implementing tough gainful-employment regulations that mandate better assistance for students landing a job after graduation, and Sen. Tom Harkin (D-Iowa) leading a crusade against educators, resulting in a massive (though error-riddled) report condemning their practices.

In its wake, for-profit educators have tumbled. Apollo Group (NASDAQ: APOL  ) saw a 14% drop in degreed enrollments in the fiscal first quarter at its University of Phoenix division, the largest college in the country, and its stock is down 63% from a year ago. Corinthian Colleges (UNKNOWN: COCOQ.DL  ) , which came in for particularly sharp words in the Senate report for having a student loan default rate 64% higher than the industry average, is operating under special monitoring procedures from Education, which disputes its calculations of financial responsibility as required to receive federal Title IV funding. It may force the school to post a letter of credit that could significantly hamper its ability to operate and may put it at odds with its lenders.

Sent to detention
Cost-cutting, layoffs, and campus closures have also been the hallmark of the industry lately. Career Education (NASDAQ: CECO  ) announced it was closing 23 campuses recently and laying off 900 employees as new enrollment dropped 23% and it reported losses of almost $110 million in the first three quarters of 2012.

While I don't support the government's war against the schools, it doesn't mean it's the best use of a student's money to go to one, either. And it's certainly not a particularly good time to invest in them. The stricter admission policies and heightened regulation have caused more students to hesitate enrolling, making it difficult for the schools to raise tuition rates. On top of experiencing higher bad debt expenses as a percentage of revenues even as its revenue per student declines, ITT also just reported it would pay Sallie Mae $46 million to settle a loan dispute stemming from an agreement it signed with the student lender back in 2007. The educator just keeps flunking out.

End of the marking period
With the first gainful-employment report cards due out by the end of the month, for-profit educators might be in for a rough period should they once again put the industry in a poor light. Some educators indicate they are already in compliance with the standards, such as DeVry (NYSE: DV  ) , which said that before the courts gutted most of the regulations, it didn't have any programs that failed to meet the standards.

ITT doesn't say whether its programs passed or failed, but it does note it was changing a bunch of programs to conform with the requirements and that those standards were also putting pressure on tuition rates because students can't have too much indebtedness if the school wants to continue receiving federal funding.

Although the schools look cheap at these depressed valuations, they have a lot of risk attached to them yet. ITT goes for less than three times earnings and around five times estimates, making it one of the cheapest for-profit schools around, but with this cloud hanging over them, I couldn't recommend touching any of them at the moment.

Let me know in the comments box below whether you agree you'd have to be a dunce to invest here, or if you think these companies are about to graduate to the next level.

Looking under rocks
While for-profit schools have a role in the economy, they might not be the best place to park your money. Really, the best investing approach is to choose great companies and stick with them for the long term. In our free report "3 Stocks That Will Help You Retire Rich," we name stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. To read it, click here now.

Read/Post Comments (3) | Recommend This Article (6)

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 January 30, 2013, at 6:43 PM, victobiz wrote:

    Gems in the dumpster.They were great shorts last year. When Growth companies break the trend this is what happens. A lot of them will probably be great investments in the coming years. With ESI you have a company that has been buying its current market cap in stock buy backs for the last few years, bad use of its cash. With no plans to do this in the coming year, they will start accumulating a lot of excess cash. They took a large 1 time hit for several years of bad accounts receivable this quarter. Also student constant default rates are going down nationally. Enrollment for next year is -5 to +5 with expectation of flat; growth contraction is turning. ESI effectively lost 1 quarter of earnings for 3 years of bad loans. 50%+ of the shares float are short. The PE is 3, and this company has high margins.

  • Report this Comment On January 31, 2013, at 12:49 PM, pentiumc wrote:

    Motley Fool is unjustified in blasting these stocks nonstop. Most private technical colleges do an excellent job of training people, working closely with related businesses to ensure what they're teaching is in demand and offering job placement assistance during and after completion. Compare their stats with the horrendous number of unemployed public college grads - it's deplorable!

    Because of ITT Tech my husband still has a great paying job he loves, after getting his degree there 20 years ago. Public colleges fail to teach hands-on skills and their degrees are filled with unrelated "fluff". Public voc-techs don't have admissions standards (and have out of date teaching staff) so you've got many unmotivated ill-equipped learners dragging down the class. America needs quality technical workers, or it will face even more jobs sent overseas.

    It's quite tiring, seeing MF constantly slam private technical education like DeVry and ITT. They do a great job getting people in to the workforce. Their stock will go up in the next year, and MF will have missed the boat.

  • Report this Comment On February 26, 2013, at 7:17 AM, TMFCop wrote:

    FWIW, I don't bash the for-profit school model and am probably one of the few defenders around here of them. That doesn't mean the fees charged for the degrees earned is always justifiable, but I feel the same way about "regular" colleges too -- perhaps more so.

    Students voluntarily go to these schools so the government shouldn't be interfering with them. Yet they are, and that's where the risk to investors comes in and that's what I've been highlighting with them.

    It's like the tobacco companies back in the 80's and even the saber rattling going on against gunmakers. However much I support their right to run their business since adults voluntarily enter into contracts with them, it doesn't mean it's always a good time to invest in them.

    And the latest SEC investigation into them that sent shares tumbling once again proves my point. I'm not even sure why ITT making arrangements with third parties to cover tuition costs not covered by federal loans would be a problem (that's what the SEC is investigating), but the costs of having to defend itself against these myriad attacks builds up over time.

    There's no doubt this administration is trying to drum the for-profit colleges out of business. The animus against them is a high hurdle to get over and if you're going to be putting your money into them you have to understand the risks associated with them.


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