Does Bridgepoint Education Pass Buffett's Test?

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We'd all like to invest like the legendary Warren Buffett, turning thousands into millions or more. Buffett analyzes companies by calculating return on invested capital, or ROIC, in order to help determine whether a company has an economic moat -- the ability to earn returns on its money above that money's cost.

In this series, we take a look at several companies in a single industry to determine their ROIC. Let's take a look at Bridgepoint Education (NYS: BPI) and three of its industry peers, to see how efficiently they use cash.

Of course, it's not the only metric in value investing, but ROIC may be the most important one. By determining a company's ROIC, you can see how well it's using the cash you entrust to it and whether it's actually creating value for you. Simply put, it divides a company's operating profit by how much investment it took to get that profit. The formula is:

ROIC = net operating profit after taxes / invested capital

The nuances of the formula are explained in further detail here. This one-size-fits-all calculation cuts out many of the legal accounting tricks (such as excessive debt) that managers use to boost earnings numbers, and provides you with an apples-to-apples way to evaluate businesses, even across industries. The higher the ROIC, the more efficiently the company uses capital.

Ultimately, we're looking for companies that can invest their money at rates that are higher than the cost of capital, which for most businesses is between 8% and 12%. Ideally, we want to see ROIC above 12%, at a minimum, and a history of increasing returns, or at least steady returns, which indicate some durability to the company's economic moat.

Here are the ROIC figures for four industry peers over a few periods.

Company

TTM

1 Year Ago

3 Years Ago

5 Years Ago

Bridgepoint Education178.2%*(1,983.1%)(626.9%)NA
Apollo Group (NAS: APOL) 144.2%78.4%89%209.6%
Corinthian Colleges (NAS: COCO) 5.8%15.7%7.2%8.8%
ITT Educational Services (NYS: ESI) 1,433.2%627.8%773.9%(176.1%)

Source: S&P Capital IQ. TTM=trailing 12 months.*Because Corinthian did not report an effective tax rate, we used its 39% rate from one year ago.

Bridgepoint Education currently has very high returns on invested capital, but its past returns were strikingly low. Don't be afraid: Both these negatives result from negative invested capital, which is a good thing. ITT Educational Services has also grown its returns dramatically from five years ago, largely by keeping its invested capital in check, while Apollo and Corinthian have decreased their ROIC over the same time period.

While Bridgepoint's current returns are very high, the for-profit education sector has come under attack as the government has criticized Bridgepoint and its peers for having extremely low student loan repayment rates. However, Bridgepoint has outperformed its peers in repayment rates and has increased its enrollment even in this negative environment.

In addition, Bridgepoint has improved the value of its shares by using some of its cash to repurchase a substantial amount of its stock, returning cash to shareholders in a tax-efficient manner.

Businesses with consistently high ROIC show that they're efficiently using capital. They also have the ability to treat shareholders well, because they can then use their extra cash to pay out dividends to us, buy back shares, or further invest in their franchise. And healthy and growing dividends are something that Warren Buffett has long loved.

So for more successful investments, dig a little deeper than the earnings headlines to find the company's ROIC. If you'd like to add these companies to your Watchlist, click below:

At the time this article was published Jim Royal, Ph.D., does not own shares of any company mentioned here. The Motley Fool owns shares of Bridgepoint Education. Motley Fool newsletter services have recommended writing puts in Bridgepoint Education. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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