The Final Search for a Diamond in the Rough

For the past two days, I've been combing through the for-profit education sector in search of a diamond in the rough. Though I would never argue that I'm a fan of the industry, it's worthwhile to find schools that are doing right by their shareholders and their students. Over the long run, the two are inextricably linked.

So far, we've looked into:

Today, I'll be zeroing in on what I think the most important metric is.

But first, shortcomings of our first two metrics
If, as I discussed on Wednesday, student enrollment is falling nationwide in for-profit schools, but those schools still provide a quality education, then it stands to reason that they'll survive this tumultuous period and come out the other side in one (albeit smaller) piece.

And if, as I discussed on Thursday, the government is providing most of the funding for the students to attend school, but the education is ultimately fruitful, then is that really a problem? If the for-profit schools are truly doing their jobs, then we should have a more educated, financially stable population in America. If you ask me, that's taxpayer money well-spent.

The metric that I think best takes the whole picture into account: student-loan default rates.

Why do I care so much about this metric?

Let's think about it.

Student-loan default rates are able to tell so much more of the story. Sure, in the perfect world, we would be able to sit in on classes and follow each graduate to see how helpful college was.

But we can't do that; so I think student-loan default rates are next best thing. It lets us know if the money spent on college was a worthwhile investment. In one sense, if students can't pay back their loans, then their return on investment is awful.

What to look for
The federal government has recently changed the rules for how educators record default. Under the new rules, numbers are culled from cohorts of students three years removed from their time in college. If 30% or more of these students have defaulted on their loans, the school enters a probationary period. If the numbers remain north of 30% for three years or more, then the school is in danger of losing Title IV funds.

School

Student-Loan Default Rate
Corinthian (Nasdaq: COCO  ) 38.1%
ITT Tech (NYSE: ESI  ) 26.5%
Apollo (Nasdaq: APOL  ) 20.9%
Bridgepoint (NYSE: BPI  ) 19.8%
Education Management (Nasdaq: EDMC  ) 16.1%
Strayer (Nasdaq: STRA  ) 12.8%
American Public (Nasdaq: APEI  ) 11.0%

Source: Department of Education, numbers for the 2008 cohort.

Unacceptable excuses
Corinthian CEO Jack Massimino defends such results, saying: "We deal with the most difficult students in American education, and as a result we get criticized. At the end of the day these students are graduating and getting opportunities they've never had before. The world's passed these students by, and we're giving them a second chance."

There's a whole lot that's wrong with that argument. These are just two examples:

  • "These students are graduating" -- wrong. A 2010 report from the Education Trust shows that just 22% of students in for-profit schools complete their undergraduate work in six years.
  • "We're giving them a second chance"-- a second chance for what? Getting into debt? Because students at Corinthian are defaulting at such an alarming rate, and because student loans can't be canceled out by bankruptcy, such debts can stay with students for a lifetime. If they were getting tools to help them, surely students could find employment that would justify their decision to go to college.

The rest of the pack
Clearly, Corinthian and ITT Tech are in troubled waters when it comes to student-loan defaults. While the Department of Education may be willing to bend the rules from time to time on the 90/10 rule on Title IV funding, I highly doubt they'll do the same with this metric.

Apollo and Bridgepoint come right in the middle of the pack. It will be very important to see which direction the numbers go from here, as a slight uptick could land them in the company of Corinthian and ITT.

From looking at the numbers, Education Management, Strayer, and American Public have been doing an admirable job at educating their students. A combination of three factors -- reasonable tuition, high job placement, and actual program completion -- all help students from these schools repay their debts.

And the winner is ...
We're not quite done yet. If you've been following along the past three days, then congratulations are in order. We've evaluated the three major risk factors to consider when evaluating for-profit schools. Tomorrow, I'll wrap it all up by looking at all of these factors and revealing which of these schools would qualify as a diamond in the rough.

Have thoughts on what's been covered so far? Sound off in the comments section below.

Fool contributor Brian Stoffel does not own shares in any of the companies mentioned in this article. Motley Fool Options has recommended a call spread position on Bridgepoint Education. The Fool owns shares of American Public Education, Bridgepoint Education, and Strayer 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 (8) | Recommend This Article (7)

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 May 16, 2011, at 5:34 PM, Caroldonab wrote:

    Your research forgets one important point, students are usually not working toward a four year dipolma. Each school has a very complicated mix of schools that bear little resemblence to each other. A company that has both nursing schools and truck driving schools makes comparisons difficullt.

    Don B

  • Report this Comment On May 16, 2011, at 9:14 PM, TMFCheesehead wrote:

    @Caroldonab-

    True, but I would hope that the tuition being charged for the different schools was in proportion to what future earnings might be in that profession. If that was the case, then repayment rates should be comparable across the different types of schools.

    Brian Stoffel

  • Report this Comment On May 17, 2011, at 1:00 AM, MKJ4567 wrote:

    How can you write an article and even consider EDMC who has 11 State Law Suits coming its way as well as the DOJ joining the suits as well as EDMC facing a whistle blower. Then add basically the same problems to the whole group!

  • Report this Comment On May 17, 2011, at 10:06 AM, TMFCheesehead wrote:

    @MKJ4567-

    Those lawsuits are certainly a concern, and still pending. If you read above, though, I think this article was largely a fact-based examination of student-default rates using information provided by the Department of Education.

    Brian Stoffel

  • Report this Comment On May 17, 2011, at 12:57 PM, financeguy85 wrote:

    Brian,

    Thank you for these articles. I have been researching for-profit education myself for a few months now. I decided to buy STRA because its fundamentals look fairly compelling and the dividend is attractive and well-sustained. Please keep these coming as your research into this sector progresses.

  • Report this Comment On May 17, 2011, at 4:23 PM, p2i wrote:

    No, he doesn't own any of the stocks, but he neglects to state which ones he is short.

  • Report this Comment On May 17, 2011, at 8:29 PM, TMFCheesehead wrote:

    @ p2i-

    I'm not short any of these stocks.

    Brian Stoffel

  • Report this Comment On May 19, 2011, at 10:40 AM, Caroldonab wrote:

    Brian

    The schools are different, and the level of sophistiation has wide differences. Classes are offered for six months with a certificate to four year nursing degree's. The costs and results vary widely. Comparisons are not meaningful unless the wide diversity of options offered are taken into consideration.

    Don

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