Seeing Past the Bad Press

 | Oct 25, 2011 | 10:00 AM EDT
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Sometimes, an industry will get knocked about because it the public has deemed it to be a wrongdoer in some way, and of late the for-profit college industry has been getting bad press.

These universities are accused of using high-pressure tactics to lure in students, and for accepting students who are unqualified to pursue a college education, making it likely these students will quit school and not get a degree. Most of these students use loans -- and the result, say the critics, is that these students renege on their loans because they cannot afford to repay them.

Others have noted that such schools attract higher-risk students who are poorer, working-class and otherwise non-traditional. That is, they are less likely to finish their degree -- something that would hold true whether they attend a for-profit or nonprofit university.

I am not here to pass judgment on the morality of these for-profit schools. They certainly provide a needed service, as community and other nonprofit colleges around the country are so strapped for money they have cut back on their class offerings, making it harder for students to graduate. The capacity these for-profits bring to the market is certainly beneficial.

If the federal government actually limited the ability of these universities to attract students who pay via federal loans -- and some for-profits reportedly earn up to 90% of their revenue from student loans – this would undoubtedly affect the for-profit college industry. But right now that doesn't seem all that likely to happen.

Aside from this, two of my guru strategies are very positive on the for-profit college industry, namely the Peter Lynch and Joel Greenblatt strategies. I have created these by computerizing the strategies described in the books of each of these well-known gurus.

The most notable variable in the Lynch strategy is the P/E/G ratio, which is the price-to-earnings ratio, relative to growth. It measures how much an investor is paying for growth, given the stock's current price and the company's growth rate. The strategy sets 1.0 as the acceptable upper limit to the P/E/G, which translates into a maximum of paying $1 for every 1 percentage point of growth. Another factor considered is the debt-to-equity ratio.

The Greenblatt's strategy rests entirely on two criteria. One is earnings yield, which is calculated by dividing a company's earnings before interest and taxes by its enterprise value. Enterprise value includes not only share price but also the amount of debt used to generate earnings. The company in question is ranked by this criterion among all the thousands stocks in our database. The second criterion is return on total capital, which examines how well a firm uses the capital it employs. Again, the company is ranked from among all the stocks in our database. The final step involves ranking each stock based on a combination of the first two criteria.

Three for-profit educational companies pass both the Lynch and the Greenblatt strategies: Bridgepoint Education (BPI), Career Education (CECO) and DeVry (DV).

Bridgepoint has an online campus, and two traditional campuses, including Ashford University in Iowa and University of the Rockies in Colorado. In total, the company has in excess of 88,000 students. Career Education operates 95 schools in 23 states, plus online offerings and has over 100,000 students. DeVry operates from nearly 100 locations in the U.S. and Canada, as well as online, and has about 85,000 students.

Looking at the Lynch strategy, Bridgepoint has a P/E of 7.25 and a growth rate of 33.47%, based on the average of the three- and four-year historical earnings-per-share growth rates, giving it a highly favorable P/E/G of 0.22. In addition, the company carries no debt. The Greenblatt strategy ranks the company at No. 11 based on earnings yield, and at No. 52 based on return on total capital -- and an impressive No. 4 for its final ranking.

Career Education does not rank quite as highly as Bridgepoint, but it is still in very desirable territory. It ranks at 14 for earnings yield, 206 for return on total capital and 23 for its final ranking. By the Lynch strategy's lights, the company has a yield-adjusted P/E/G that's a perfectly acceptable 0.60, while it also has a very low level of debt, with equity at about 7x debt.

DeVry has a P/E/G equal to Bridgepoint's -- 0.22 -- with zero debt. The Greenblatt strategy ranks the company at 78 for its earnings yield, 94 for its return on total capital and 17 for its final ranking.

When one strategy gives a company its highest rating, you should pay attention. Each of these companies earns the respect of two strategies. That's impressive. The for-profit education industry has been battered by poor press, but these companies are well managed and doing nicely. People will continue to value education and these companies are in an enviable position to take advantage of this.

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