The Problem With For-Profit Educators

This article is part of our Rising Star Portfolios series.

You'd think companies trying to make a buck would shy away from industries dominated by non-profit entities. Not so in education.

The opportunity that companies like Apollo Group (NYSE: APOL), operator of the University of Phoenix, have tapped is clear. In a world where the hurdles to better employment are increasingly educational, traditional colleges have continued to cater their offerings to the 18-to-24-year-old crowd. Demand for educational options for "non-traditional" students, who need to fit their curriculum around work, family, and other obligations, is monstrous. Around 40% of enrolled students today are not part of the traditional undergraduate demographic.

That's where the for-profit educators came in. Brandishing degree paths characterized chiefly by their flexibility -- in class times, program lengths, and often extensive options to complete coursework online -- the industry growth over the last decade has been extraordinary. Today, approximately 1.8 million students are enrolled in for-profit colleges. The University of Phoenix alone accounts for about 2.3% of the entire student population. (Think about that for a moment.)

Here are some of the bigger players:

*Estimate based on author's calculations.

But there is a problem: The people running for-profit colleges are chiefly responsible to their shareholders, not their students. There are good reasons that education has historically been offered by non-profit institutions. Incentives are powerful forces, and when you mix powerful monetary incentives with inherent conflicts of interests, you can't be surprised when the milk turns sour.

The three biggest problems in the industry, in my opinion, are direct results of these conflicts of interest:

1. So-called guidance counselors, supposed to be offering unbiased advice to prospective students, would better be termed salespeople, since they have been paid commissions based on the number of students they signed up.
2. There has been scant evidence that graduates of for-profit education schools have been any more able to land higher-paying jobs than they were before they enrolled.
3. Many students have taken on substantial debt loads to fund their tuition and found themselves unable to pay it off, especially without any improvement in employment after graduation.

Those are the major problems in a nutshell, and they help explain why an index for the industry is down more than 35% since last April.

Why should you care?
As an investor, I love beaten-down industries. Rarely are all companies in an industry under attack equally deserving of the ax, but human emotion -- fear, in particular -- tends to result in the stocks of all such companies receiving the same treatment. If you can overcome such behavioral biases, you might uncover a diamond in the rough.

That just might be the case in the for-profit education sector. The problems I outlined certainly don't apply to all industry players identically. I, for one, have begun investigating several of the companies listed above. To keep up to date with my thoughts and trades in my free online portfolio, follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios) here.