For Investors, It Pays to Skip School Stocks

The S&P Education Services Index, which tracks for-profit educational firms' shares, is down 21% this year and 28% annually over the past three years, versus the S&P 500's gains of 10% and 21%, respectively.

At the very least, the industry is due for a shakeout, given the overriding trends it faces. "Despite a spectacular multi-decade run, we believe increased regulatory scrutiny of the for-profit education sector is forcing participants to react and adapt to potentially game-changing rules, which are likely to alter the industry landscape for years to come," wrote Peter Wahlstrom, Morningstar's educational services industry analyst, in a research note last week.

Similarly, S&P analyst Michael Jaffe reported that "following much improved operating results in 2009 and 2010, many U.S. for-profit educators have been experiencing highly diminished performances over the past few quarters, and we see results remaining (that way) for an extended period.

"We think the less favorable outcomes have stemmed mostly from new regulations being put in place by the Department of Education" in an effort to lower student loan default rates, he said.

Although those regulations, which track post-graduation employment and wages and tie them to student loan defaults, "turned out to be less severe than those originally proposed, we still believe this rule will be the most challenging of the group of newly created regulations," Jaffe said.

Federal student aid programs can account for as much as 90% of some for-profit colleges' revenues so the threat of a loss of part or all of such programs could be a serious blow.

The pressure of having to significantly reduce those loan default rates are forcing for-profit schools to toughen their admissions and loan eligibility standards, which will put a big dent in the size of their student body and crimp their profits.

The new regulations take effect in July, but deficient schools' programs will get three years to improve default rates before they lose their eligibility for government-funded programs.

But that's not the only regulatory challenge on the horizon, as last week a bill was introduced in Congress that would prohibit colleges from using money from federal student assistance programs to pay for advertising, marketing and recruitment.