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Strayer University Cuts the Grade: Analyst

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- Magic Formula Investing (MFI) looks for stocks with low valuations as measured by high earnings yield of excellent companies as measured by high returns on tangible capital.

So it is no surprise that the formula is in love with the for-profit education sector. These historically high-margin, high-growth businesses have come under mortar fire from Congress and the Department of Education over the past year over low student loan repayment and high dropout rates, with several potentially game changing regulatory proposals looming over them.

Under these conditions, stock valuations have plummeted and practically the entire sector has shown up in MFI at some time or another. Currently, the screens select a total of six for-profits: Apollo Group (APOL), Capella (CPLA), ITT (ESI), Career Education (CECO), DeVry (DV), and the one I want to look at today, Strayer Education (STRA).

Strayer is one of the smaller players in this business, with just 89 campuses in 21 states and D.C., and roughly 56,000 students. By contrast, Apollo Group (University of Phoenix) has about 405,000 students. The company operates primarily in the mid-Atlantic states and the South. Strayer focuses on working adults looking who are looking to build on their prior education by offering most classes in the evenings or weekends, and online.

A key differentiator here is that the vast majority of Strayer's students (81%) are working towards four-year bachelor or master's degrees. Many competitors in this space are focused on trade-based disciplines or two-year associates degrees.

In general, bachelor and master students are more likely to pay back their loans, more likely to stick with the program and not drop out, and are more profitable to the company. As an example of their desirability, Apollo Group recently switched strategy to try to drive increases in their higher level degrees after years of "churning and burning" associates students through Axia College (to a sub-10% graduation rate).

A discussion of these stocks has to begin with the headline risks facing them. The federal government's Title IV loan program accounts for the vast majority of sales at these firms. One rule in place for limiting the amount of student loans is called the "90/10" rule. Basically, it states that a proprietary (i.e., for-profit) educator cannot derive more than 90% of cash sales from the federal government for two consecutive years. If it fails, that company becomes ineligible for Title IV funds for two years -- a virtual death sentence for any for-profit firm.

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