As a former teacher and son of a current university professor, I've always been interested in following for-profit education companies. By and large, this interest has led me to believe that staying away from the industry -- as an investor -- was the smart thing to do.
Yesterday, I showed how declining new student enrollments at DeVry (NYSE: DV ) , ITT (NYSE: ESI ) , Apollo (NASDAQ: APOL ) , Corinthian Colleges (NASDAQ: COCO ) , and Bridgepoint Education (NYSE: BPI ) coincided with dramatic drops in the share prices for all of these stocks. Even American Public Education, which showed an increase in new student enrollment between 2010 and today, saw its stock drastically underperform the market.
Today, we'll be examining how each of these schools measures up against one of the most important rules in the industry.
The 90/10 rule
An enormous portion of the revenue that these schools receive comes not from students, but from federal government loans. Because these schools tend to focus on students who may have a hard time paying full tuition out of pocket, it makes sense that a lot of money is provided through Title IV federal funding.
At the same time, the government wants to make sure that the schools aren't just siphoning away tax dollars to provide a piece of paper -- a degree -- to students who may or may not be benefiting from their college experience.
That's why every school needs to derive less than 90% of its revenue from Title IV funding. If a school eclipses that benchmark, it's put on probation. If it continues above the benchmark for a second consecutive year, the school loses its eligibility to receive Title IV funding. As you'll see, that usually means a death blow for the school.
Here's where the six schools I mentioned stood at the end of 2012, compared with the end of 2010.
There are a couple of key takeaways here. The first is that DeVry and Corinthian have done a good job at lowering the proportion of funds coming from Title IV. That's especially important for Corinthian, since, combining all schools, the company was in danger of losing funding back in 2010.
The second takeaway is that American Public and ITT showed alarming increases in Title IV funding, while Apollo -- parent company to the University of Phoenix -- is in serious danger of violating the 90/10 rule.
Three important caveats
When it comes to calculating the 90/10 rule percentages, only Title IV funds are counted. Money from the Department of Defense -- by way of the GI Bill -- doesn't count against a school.
That's important to understand with American Public, which had spent the better part of its life as a school focusing solely on catering to active-duty and retired military personnel. Over the past two years, however, the school has reached out to nonmilitary students, and doing so has accounted for a gargantuan leap in public funding.
Another detail investors need to be aware of is that, on multiple occasions, members of Congress have suggested making the GI Bill funds eligible to count toward the 90/10 rule. Doing so would be an enormous problem for American Public, but less so for some of the other schools that also enroll military personnel.
Finally, members of Congress have suggested in the past changing the 90/10 rule to an 85/15 rule. If that were to happen, American Public, Apollo, Corinthian, and Bridgepoint would all currently be in probation for violation of the rule.
There are some very specific risks that investors need to be aware of here, and I don't think those risks are worth it. Instead, I like investing in innovative industries that create value and don't need government assistance just to produce questionable results. If you want to find out about one such industry, you should read up on 3 Stocks to Own for the New Industrial Revolution. I own two of these stocks and will continue to add more as time goes on. All you need to do is click here to learn more.