Watch stocks you care about
The single, easiest way to keep track of all the stocks that matter...
Your own personalized stock watchlist!
It's a 100% FREE Motley Fool service...
Legendary value investor Seth Klarman once wrote, "Value investing is at its core the marriage of a contrarian streak and a calculator." The mathematical component of value investing is the easy part and can be quickly mastered by anyone with a high school diploma. It is standing apart from the crowd with a divergent point of view that is hard. It requires confidence in your analysis and the mental fortitude to believe your own judgment when smart investors believe you're wrong.
This may not be a popular opinion, but I believe there are investment opportunities within the for-profit education industry. As a group, these stocks have suffered greatly because of scrutiny from the Senate Health, Education, Labor, and Pensions Committee and the Department of Education. It was just last week that HELP Chairman Tom Harkin (D-Iowa) held a hearing focusing on Bridgepoint Education. Needless to say, Harkin is not a fan. For a full rundown, read my article about the proceedings.
Market Cap (millions)
52-Week Stock Performance
|American Public Education (Nasdaq: APEI )||$773||(9%)|
|Apollo Group (Nasdaq: APOL )||$6,054||(33%)|
|DeVry (NYSE: DV )||$3,630||(21%)|
|Education Management (Nasdaq: EDMC )||$2,550||(19%)|
|Grand Canyon Education (Nasdaq: LOPE )||$702||(36%)|
|ITT Educational Services||$2,027||(35%)|
|Lincoln Educational Services (Nasdaq: LINC )||$349||(41%)|
|Strayer Education (Nasdaq: STRA )||$1,854||(43%)|
|The Washington Post||$3,458||(6%)|
Source: Capital IQ, a division of Standard & Poor's.
I expect that there will be winners and losers in the industry, and I do not advocate indiscriminately buying companies on this list. Investors wanting to find a few stocks that should do well are going to have to do their homework. I've been investigating the for-profits for the past couple months, and I'll share a few tips to get you started.
Title IV is everything
Title IV is the section of the Higher Education Act of 1965 that provides financial assistance from the federal government to students attending college. It was reauthorized in 2008 with the Higher Education Opportunity Act.
Eligibility to participate in Title IV funding is the lynchpin of the for-profit education business model. Since these schools tend to serve students who do not have well-off parents writing tuition checks, more than 90% of students attending for-profit schools receive student loans through the Title IV programs. If a school were to lose its eligibility to participate, the evaporation of its primary revenue source would be catastrophic.
Therefore, investors need to determine whether an institution's Title IV eligibility is at risk. An underappreciated piece of this puzzle over the next few years will be the accreditation process. To be eligible for Title IV, an institution must be accredited by an agency recognized by the secretary of education. Sylvia Manning, president of the Higher Learning Commission, a regional accrediting body, said at last week's Senate hearing that the standards for accreditation are getting tougher. In the future, greater emphasis will be placed upon student persistence and retention as this is the greatest problem facing the educational system, in her opinion. What this means for investors is that for-profits with high rates of student withdrawal have to take action to improve retention before their accreditation comes up for review.
The other significant component of Title IV eligibility is student loan default rates. Harkin's report, "The Return on the Federal Investment in For-Profit Education: Debt Without a Diploma," highlights a problem pervasive in the industry: students attending for-profit schools accumulating student loan obligations that they turn around and default on at a rate considerably higher than students who attended public four-year institutions.
While Harkin's focus is on student outcomes, investors also need to be aware of the implications of climbing student loan default rates. Beginning with fiscal 2012, schools that have a three-year cohort default rate over 30%, defined as percentage of borrowers defaulting, can face sanctions including loss of eligibility for Title IV. Schools that are already near this threshold need to present investors with a compelling plan to improve performance, otherwise the stock is simply too risky to own.
When you are analyzing a for-profit institution, you have to understand as thoroughly as you can the security of its access to Title IV funding.
But be wary of consolidated results
Some for-profit companies, like Bridgepoint Education, Corinthian Colleges, and Lincoln Educational Services, operate multiple institutions. Sometimes management will provide consolidated data on metrics like student loan default rates, retention, and graduation rates. This can be misleading to investors if one of the company's institutions is performing well and masking weak performance at another school.
Investors need to be aware of default rate trends on a school-by-school basis, and not just for the corporate entity as a whole. If the company doesn't break out the data, you can get it yourself from a database made public by the Department of Education. This will let you know if individual schools should be considered "at risk" and what the impact on the company's earnings as a whole could be. Don't let management get away with massaging the data and making the company look healthier than it really is.
The future outlook
It is my expectation that for-profit schools will see slower growth and compressed profit margins in the future. The schools cannot afford to enroll students who are not willing and able to complete an online college degree. The schools will have to be more selective and screen out students at high risk of failure. They are also going to have to spend more money to increase the quality of the education and providing support services to keep students enrolled. Failure to lower withdrawal rates and loan defaults will put accreditation and/or Title IV eligibility at risk. That's a chance they can't take.
There is opportunity in the for-profit space for investors who do their homework to make some money if they can identify the companies most likely to succeed in the new environment. You should add these stocks to your Foolish watchlist so you can keep abreast of the latest news while you perform your due diligence. You can add them easily by clicking on American Public Education, Apollo Group, DeVry, Education Management, Grand Canyon Education, Lincoln Educational Services, and Strayer Education. Don't have a watchlist yet? Set one up now -- you'll get timely updates and a free copy of the special report "6 Stocks to Watch From David and Tom Gardner."