School Stocks That Make the Grade

Investors have gotten a costly lesson lately on the shortcomings of the for-profit education industry. While the U.S. stock market gained 15% over the past year, once-high-flying school stocks crash-landed, with the dozen companies operating the nation's biggest for-profit colleges losing 32%, on average.

And the averages don't do justice to the underlying ruin. The industry's standard-bearer, Apollo Group (symbol APOL), tumbled 34% over the past year and actually lost ground during the bull market that began in March 2009 (all results and prices are through March 10, 2011). Corinthian Colleges (COCO) lost 74% over the past year, and Strayer Education (STRA) fell 41%.

Under a cloud. The industry has been under fire since government hearings in 2010 uncovered a litany of complaints from students who stated that they paid dearly for classes that provided neither valuable job training nor transfer credits, leaving many with a mountain of student debt and few viable job prospects.

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Now the Department of Education is hammering out new "gainful employment" rules that could restrict access to federal financial aid -- the lifeblood of for-profit institutions -- if the schools are unable to prove they're adequately preparing students for the high-paying jobs they've been promised. The proposed rules will look at students' debt at graduation compared with their total income and discretionary income. They'll also measure a school's repayment rate -- the percentage of graduates who are repaying principal on their federal loans. If schools score poorly on both measures, their students will lose access to the federal loans and aid that account for the bulk of the schools' revenues.

The new rules won't affect all companies equally. A number of schools already meet the strictest measurement in the rule, which demands that at least 45% of their graduates are paying down principal on their loans. "A few bad apples are giving the whole industry a bad name," says Morningstar analyst Peter Wahlstrom. "The Department of Education does not intend to cripple the whole industry."

Tempting bargains. The stocks of some school companies, those that are unlikely to be severely affected by the new rules, are battered enough to make them tempting buys. The key, says Gary Brisbee, an analyst at Barclays Capital, is to focus on quality: "Don't chase the cheapest stocks, because those are the companies with the biggest issues."

Worth a look is DeVry (DV), one of the oldest and most stable companies in the industry. The bulk of DeVry's schools -- Chamberlain College of Nursing, DeVry University, Carrington College California and Keller Graduate School of Management -- already meet either the toughest or the second-toughest standards on repayment. Meanwhile, the stock, at $52, sells for just 11 times estimated earnings of $4.67 per share for the 2011 calendar year.

Education Management Corp. (EDMC), which operates the Art Institutes, South University, Brown Mackie College, Argosy University and Western State University College of Law, also boasts many campuses that meet the repayment guidelines. At $19, it sells for a bit less than 12 times estimated earnings for calendar 2011 of $1.63 per share.