Are Online College Stocks Worth Buying?

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General education stocks--including for-profit education companies--have seen growth lately. Are online college stocks worth buying?

Editor's note: while Trendshare prefers to give general investing advice, it's sometimes useful to analyze an industry or sector to demonstrate how an investor might use domain knowledge to pick good potential stocks.

The Education and Training Services Industry has grown rapidly as businesses experiment with new education models. Although most higher education in the United States takes place in publicly-funded colleges and institutions (colleges, universities, and community colleges), several for-profit corporations offer education services.

What is For-Profit Education?

For-profit secondary education is an industry where corporations offer college courses and degrees. The purpose of the business isn't solely to educate students (ostensibly the goal of publicly funded colleges); it's to make money. The University of Phoenix (owned by Apollo Group) is one of the best known. The focus of such a business is to use tools of capitalism—business standards, driven by revenue, efficiency, and growth concerns—to improve the delivery of education.

There are similarities between every for-profit education business, but the industry is still too immature for the kind of systemic analysis you could perform for a steel mill or semiconductor company. There's no single standard business model (unless you're cynical enough to suggest easy access to college loans is a business model).

What is standard between these businesses is the benefit and challenge that comes from the Internet: virtual college courses.

What is an Online College?

A traditional college or university experience gathers students in a lecture hall to hear a lecture from a professor in person or in a laboratory to perform work under the supervision of a teaching assistant. An online college course distributes video lectures and materials for students to access wherever and whenever they want at their own convenience. You don't have to take Stocks for College Students 101 at 9:30 am in Brown Hall; you can view the videos at 11 at night after you get back from a late dinner with friends.

Decentralization scales well beyond the physical limits of a lecture hall; a lecture for 100 students or 10,000 takes around the same amount of work. It also reduces limitations of who students can be. No longer are you limited to everyone who lives within commuting distance of Brown Hall. You can solicit students in any state or country, if they have decent Internet access.

In simpler terms, the improvements of Internet infrastructure allow corporations to compete with local colleges on the strength of their distance learning materials. Because competition is so dear to the heart of the for-profit education industry, this is a huge benefit...

Threats to Online College Businesses

... except when it isn't a benefit. A public school can also provide its courses online. Where lab work, tests, or other physical facilities are necessary, it's as easy for a public university to rent, borrow, or trade space just as a public company can.

That's not the only threat to the for profit education industry, either.

Loss of Prestige

Even though many classes and courses and degree programs from for-profit institutions have high standards and teach well, there's still a prestige bias toward these degrees. (The modest success of mail-order degree mills in prior decades and their continued existence mills contributes somewhat, however unfairly.)

However unfair this may seem, a Ivy League degree or sheepskin from a well-regarded state school is seen as a stronger credential than a receipt from an online school. While there are a few studies purporting to show that graduates of for-profit institutions have worse job prospects than so-called traditional students, the results are not as yet conclusive.

Stricter Federal Lending Guidelines

Of course, with the easy availability of student loans from the US federal government, any for-profit business would be foolish to ignore this easy money. Cue lots of competition for students. In some cases, cue unbelievable incentives to enroll in a for-profit school when those promises might not necessarily come true.

There's no compelling evidence that the competition for federal dollars makes for-profit colleges more efficient or effective in providing education. Think about it: there's little incentive to invest in a student's long-term success when signing up the student opens up the revenue gateway to a pile of federal dollars that the student doesn't have to repay to the business and which are very difficult to discharge through bankruptcy. You could make the same claim against public education institutions, but the profit motive there is different.

Yet lacking obviously better results—at least, not as the theory of competition by corporate colleges should predict—the federal government may restrict the amount of loans available to students at these institutions. That means more competition for less money. That may mean consolidation between competing institutions or failure of smaller/less successful institutions or slower growth for everyone.

It may also mean a new business model or a standardized business model, but time will tell.

Competition from MOOCs

If an online college course can reach 100 people and 1,000 people with the same ease, why not 10,000 people? A MOOC or a massive online open course is a class offered over the Internet for multitudes of simultaneous students. Some MOOCs are available for free from well-known institutions such as Stanford and MIT.

You may have to pay for grading and certificates of completion or other qualifying credentials, but taking a few specific classes and paying smaller fees might be a much better bargain than moving to California or Massachusetts and enrolling for a few semesters. (It's probably easier to qualify, too.) If you're already paying for an online course, why not pay for one from a school with an older and much more prestigious reputation?

The MOOC trend may further the trend of à la carte education, eventually disrupting the idea of degree programs entirely. Why bother spending four, five, or six years building up credits toward an official degree when you can take a couple of dozen credit hours to improve very specific skills?

Are For-Profit Education Stocks Worth Buying?

The education and training services industry has its benefits: a steady supply of customers, an economy in transition which needs training and education, the potential to use market principles to make education more effective and efficient. Some public companies are making real money in this industry.

There's no singular economic moat around for-profit colleges, however. The same Internet which gives them the ability to reach more customers and students gives their competitors similar opportunities. Online classes are great opportunities, but they're not limited to anything the Apollo Group/University of Phoenix can provide.

There may be values in this market, but the risks are real. If there are true opportunities for value investors, they may be with smaller companies which don't try to compete with the Stanfords and MITs. Instead, they provide products and services to the Stanfords, MITs, and corporate instututions.

Does the existence of massive online college courses ruin the model of profit-based education? Not necessarily. Does the risk to the firehose flow of federally funded education loans threaten the business of Internet colleges? Not necessarily. Any industry faces risks like this. New industries—or established industries with new business models—will have to answer existential questions when disruptions such as ubiquitous broadband or massive competition.

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