Investors who jumped on surging education stocks earlier this year may have received a painful lesson from the school of hard knocks. Education stocks -- more precisely, the shares of for-profit companies specializing in using the Internet to deliver post-high school education -- posted blistering returns from late February last year to late February this year. During that period, the Nasdaq Composite climbed 51%, but the shares of three education stocks did even better than that. ITT Educational Services ( ESI) gained 118%, Strayer ( STRA) rose 99% and Education Management ( EDMC) climbed 79%. But it's been a very different story in the last month or so. ITT Educational Services has plunged 47%. Education Management has dipped 6%. Strayer is up slightly. The Nasdaq, by comparison, fell about 2.3%. What happened?
In ITT's case, what happened was a federal investigation into its business practices. On Feb. 25, U.S. Postal Service inspectors and local county sheriffs executed search warrants and shut down the company's corporate headquarters and 10 of its 77 campuses. ITT, the largest U.S. operator of post-high school technical schools, said that grand jury subpoenas issued by the U.S. District Court in Houston sought data on student placements, retention, salaries earned by school graduates, recruitment and admissions. So far, U.S. Attorney Michael Shelby of the Southern District of Texas has said only that charges have not yet been filed against the company. Class-action lawyers have drawn their own conclusions in lawsuits they've filed against ITT Educational Services. The lawsuit filed by Milberg Weiss Bershad Hynes & Lerach alleges that the company has committed securities fraud by falsifying enrollment, graduation and job placement rates; by using those falsified records to secure federal grants; and, finally, by reporting inflated revenue thanks to those falsifications. Welcome to the wonderful world of investing in for-profit education, where the very real promise of the sector is exceeded only by the potential that an individual stock will blow up. I think the potential of the sector is so huge, though, that it's worth trying to find a way to navigate your way through the minefields. First, though, here's the big picture that makes it worth going to the trouble of figuring out this sector in the first place.