Can For-Profit Colleges Survive Regulations?

A windfall of regulations and lawsuits plaguing the for-profit college companies may threaten their bottom lines.

Jun 16, 2014 at 11:53AM

Stocks of for-profit colleges and universities have taken a beating over the past few years as the industry has become more regulated. These regulations are putting a squeeze on the profits of these companies, which makes them less viable options for long-term investors.

Cracking down
At the end of last month, the Consumer Financial Protection Bureau, or CFPB, began reviewing public comments about proposed rules that would affect for-profit educational institutions. The Department of Education drafted these rules to address growing concerns about burdensome student loan debt.

According to the National Conference of State Legislatures, enrollment at for-profit institutions has increased a whopping 225% over the past 20 years.Furthermore, the group found that these institutions now enroll about 12% of all post-secondary students, who amounted to roughly 2.4 million as of the 2010-11 academic year. 

With those kinds of numbers, it would seem that institutions in the space have more than enough students to tap when it comes to raking in aid dollars for their tuition and other fees. However, call it greed or whatever you want, the drive to make more money has led some of these institutions to engage in unscrupulous activities that have brought the wrath of government regulators.

The worst of the bunch?
This especially seems to be the case with ITT Educational Services (NYSE:ESI). In reviewing some of its bad habits, I found a Senate document that discussed the high-pressure tactics its representatives used to recruit students. One egregious act, called "poke the pain," called for agents to "remind [the potential recruit] of what things will be like if they don't continue forward and earn their degrees. Poke the pain a bit and remind them who else is depending on them and their commitment to a better future," was a statement in the document 

This guilt-trip tactic is one of the reasons why it is being sued by the CFPB. Also at issue is if ITT violated federal securities laws. The Securities and Exchange Commission is looking into whether the company filed false statements about its financials and guidance. Any improprieties over this key information should make investors run for the hills. In reaction to this news, ITT's stock fell about 21%.

Further aggravating the situation is the institution's declining enrollment. It has warned that new student enrollments for the second quarter could fall 10%-15% year over year.

To get a better idea of how the stock is being beaten up, I looked at its total return. According to Ycharts, ITT has provided a year-to-date return to investors of about negative 44%.

In the same boat
Then there is Apollo Education Group (NASDAQ:APOL), which operates the University of Phoenix. It has provided a year-to-date return of 35.93%.

Like ITT, Apollo finds itself facing a class action lawsuit from shareholders. The shareholder lawsuit involved allegations that Apollo also violated federal securities laws. Also, the state of Florida is investigating the company--in January, its attorney general subpoenaed Apollo to learn if the company used unfair and deceptive trade practices in recruiting students.

What's interesting about Apollo is its price-to-earnings-growth ratio. According to Benzinga, its PEG ratio lands it among the top four mid-cap stocks in the education and training services industry.

It has a PEG ratio of 2.31. For investors who want more insight into how a stock may trade in the future, the PEG ratio can be a valuable, evaluative tool.

DeVry leading by example
If you still like the space despite the problems of ITT and Apollo, consider some of the other players within it. One of the strongest is DeVry Education Group (NYSE:DV), which has provided a return to investors of 45% over the last year. Some interesting things about DeVry are its ability and willingness to adapt to the changing work environment. Recognizing the changing jobs landscape, DeVry has reduced its emphasis on tech programs and increased its focus on health programs.

The stock had been floating along nicely this year, closing in on its 52-week high of $47.73 toward the end of May. However, in what can be chalked up as a sympathy play, it fell at the end of May, along with ITT, to $41.58. It has recovered on news that it is building a nursing campus in Texas.

What now?
Things will get worse before they get better for for-profit colleges. With lawsuits from federal and state governments pending, as well as the proposed federal regulations, these institutions face challenges that may be insurmountable. Look to those that are making moves like DeVry in evolving the programs they offer. Otherwise, be forewarned that the space may not be worth your investment dollars.

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Tedra DeSue has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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