2 shares to buy and 2 to avoid in the next boom sector

After the mining boom many investors like to look for the next boom sector in the Australian economy, with areas like agriculture, tourism, dairy, or aged care often touted as the places to be.

As part of the services sector education is another clear growth area in theory as the globe’s growing middle classes demand better and higher education services, while online learning at schools or private tuition outside schools are other growth areas.

However, investors must be careful to distinguish between businesses in the education sector – as they often have very different profit-making business models.

Some are truly pedagogical in nature and aligned to improving education standards via market leading online products and software, while others rely on regulatory largesse and demand from fee-paying international students to make profits by offering largely administrative services.

Below are two education businesses that have potential to grow quickly via their mission to improve educational standards and two to avoid due to the risks around the ‘for profit’ education sector and its reliance on third parties and regulators among others.

Two to buy

3P Learning Ltd (ASX: 3PL) is the fast-growing online education and cloud-based business that sells educational products to improve numeracy, spelling and science learning results for 17,000 schools around the world. FY15 EBITDA was $16.9 million with revenue growth of 20% forecast in the year ahead the company’s current valuation around $273 million (16x trailing EBITDA) looks attractive for a fast-growing, scalable technology business, with healthy margins and global horizons.

Kip McGrath Education Ltd (ASX: KME) is a private tuition franchisor in the school age space that is growing strongly thanks to its global horizons, technological products, and significant demand for private tuition to improve children’s learning. Private tuition is a big growth area within many emerging market countries in particular, where the private tuition space is now beginning to rival the public schooling space size wise. Kip McGrath shares are a speculative bet thanks to its position within the long-term global growth sector of private tuition.

Two to avoid

IDP Education Ltd (ASX: IEL) is a newly-listed business involved in the higher education sector, primarily in operating the International English Language Tests (IELTS). These are the English language tests overseas students commonly take to demonstrate a high level in English language proficiency to qualify for visas and courses, or to meet other legal requirements.

In fact 69% of the group’s total revenue of $309.9 million last financial year came from fees in operating the IELTS tests, although the company would not disclose what percentage of this revenue was from students failing and then re-sitting the tests when I queried this with IDP. This looks a business to give a miss as I expect it may disappoint investors in the years ahead.

Navitas Limited (ASX: NVT) is a higher education related business that has disappointed investors on and off since listing back in 2004. It has been impacted by regulatory reforms around university enrolment programs and previously lost a pathway program contract after Macquarie University concluded it was better off assuming full responsibility for its own pathway programs. Shares currently sell for $4.53 and investors will need to be comfortable with the risks around this business.

Foolish takeaway

My main tip for investors in the education space is to identify the businesses with products and services that will make them attractive to customers over the long term due to their pedagogical qualities or educational benefits, rather than those that earn more fees every time a student fails and then re-sits a test like IDP Education for example.

Selling for $1.98, 3P Learning looks an attractive prospect in the small-cap space, while Kip McGrath is an interesting prospect but its speculative nature and illiquidity mean it should only be considered by the most experienced and risk tolerant investors. Needless to say, Navitas and IDP Education are two to avoid in my opinion.

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Motley Fool contributor Tom Richardson owns shares of 3PLEARNING FPO and Kip McGrath Education Centres Ltd..

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. 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. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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