Our shares to watch in 1994: The Independent's City writers, whose portfolio rose by 25% last year, offer their tips for the coming year

THE Independent staff portfolio in 1993 showed an increase of more than 25 per cent for the second year in succession. But the extent to which it outperformed the FT All Share Index, up by 24.1 per cent, was not as marked as in 1992, when the FT All Share rose by 14 per cent.

The star performer for us, with a rise of 89 per cent, was WPP, the refinanced advertising agency which shot back into favour. Blue Circle justified its role as a tip on recovery in building materials by leaping 69 per cent, while Compass Group, the contract caterer, survived some mid-year unease over a deal with SAS to end the year strongly with an overall gain of 31 per cent.

These sterling performances more than offset dull to poor showings elsewhere. Merrydown, hit by a cut-price cider war, shed 14 per cent and Tomkins, suffering from indigestion after its takeover of RHM, fell 8 per cent. Grand Metropolitan, in common with other drinks groups but not helped by baffling accounting treatments, went nowhere, while Yule Catto held its own in an out-of-favour chemicals sector.

Now that the market dividend yield is down to barely 3.5 per cent after the strong performance last year, investors in 1994 will be beating the undergrowth looking for that increasingly rare bird - an undervalued share.

HEYWOOD WILLIAMS

The company has changed out of all recognition since the disposal to Pilkington of its bulk glass business in March for pounds 95m. The money has been spent on three sizeable acquisitions, which give Heywood exposure to the US (now 47 per cent of sales) and to growing markets (manufactured homes and recreational vehicles) to which it supplies a wide range of products.

In the UK, Auto Windscreens is having a good year, buoyed by new regulations on cracked windscreens.

The balance sheet is strong, with gearing under 30 per cent. Forecasts for the year to December 1994 are for profits of pounds 35.8m, putting the shares at 407p on a p/e of 17.5 falling to 13.1 in 1995 on profits of pounds 47.5m.

KENWOOD

In an unspectacular economic recovery, which is what seems in store in 1994, the laurels are likely to go to those companies capable of solid earnings growth. They must have a low cost base, be efficiently managed and stand ready to benefit from an increase in volumes, even a relatively modest uptick.

Kenwood Appliances is tightly run by enthusiastic and thoughtful management. As sales expand, it is moving some production overseas to cheap labour areas. It also has a good history of innovation. Many of the items it makes are in the pounds 20 to pounds 50 range (good Christmas/ birthday presents) and some, like toasters and irons, are regularly replaced. Any squeezing of consumers with the spring tax rises should not affect Kenwood too badly.

Analysts forecast profits growth of 30 per cent this year and 15 per cent next year. The p/e for the year ending this March is 15.6 and for March 1995 is 13.

SMITHKLINE BEECHAM

Pharmaceutical stocks have had a rough time over the past year, underperforming the market by almost 30 per cent thanks to the threat posed to profits by US and European healthcare reforms. Over 1994 sentiment could well change and benefit SmithKline Beecham most of all.

In the run-up to May, when SKB faces the US patent expiry of its key anti-ulcer drug Tagamet, which accounts for about 15 per cent of sales, the shares may look a little weak.

But SKB has a very strong sales force and is seeking to compete aggressively on price. The result may be a dent in rival Glaxo's Zantac sales. It has some attractive new products, including the anti-emetic Kytril, and Famciclovir, which is set to challenge Wellcome's virtual monopoly on anti-viral drugs.

SKB's talented and realistic management was the first to see the threats posed by healthcare provision changes and the quickest to react. With a prospective p/e of just over 12 for 1994 earnings, and a yield of around 3 per cent, it looks attractive.

GENESIS EMERGING MARKETS

Genesis Emerging Markets Fund Ltd, a Guernsey-based, closed-end company with a quote on the London Stock Exchange, is up about 80 per cent in 1993 thanks to the strong performance of emerging markets and a demand for the funds that invest in them.

It might be foolish to expect the same return in 1994, as the re-ratings of many emerging markets caused by the sudden fashion for them has already happened. But many companies in these inefficient markets are still undervalued and there are still a lot of economies that will grow quickly enough to dwarf growth in the West.

With most of the multiple expansion last year's story, stock-picking funds should begin to outperform others. Despite a premium of about 10 per cent to the underlying net asset value, it should do well.

FOREIGN & COLONIAL ENTERPRISE TRUST

Unquoted investments - management buyouts, start-ups and development capital deals - have not caught up with quoted. The third- quarter unquoted index (compiled by Stoy Hayward/Acquisitions Monthly) showed that the discount of unquoted to quoted equity at 47 per cent was at its widest since the unquoted index started in 1987. Venture capital, or unquoted equity, historically trails the quoted market and follows the economic cycle, swinging up when the economy swings up. Therefore the recovery is all ahead of it.

Foreign & Colonial is one of the better management houses and F&C Enterprise Trust has a good record. It has more than 70 per cent of its portfolio in the UK so should be a beneficiary of UK recovery.

The booming new issue market also means venture-backed companies are floating at fat p/e ratios on the stock market. More than 30 venture-backed companies have floated since July, so profits are rolling back into venture trusts.

AEGIS

Aegis group, Europe's largest media buyer, has been through several refinancings but much of the uncertainty over its future has now been removed. The group is well poised to benefit from the global trend by advertisers to centralise their media spending.

Two months ago, Omnicom, the US advertising group, took a substantial stake in the company - a prelude to a possible bid. With a pounds 1bn-plus turnover, Aegis should make pre-tax profits of pounds 30m this year, valuing the shares, at 17.5p, on a mere eight times earnings.

REED INTERNATIONAL

The merger of Reed International and the Dutch Elsevier, consummated exactly one year ago, looks set to evolve into one of the most attractive investments in global publishing, both in hard copy and on- line services, with an emphasis towards the unexploited academic and business markets.

Reed shares will move ahead as the merger benefits become increasingly apparent. A p/e of 20 on 1994 pre-tax profits of pounds 615m should fall sharply in 1995 and a yield of 2.75 per cent is a useful side-prop.

----------------------------------------------------------------- TIPS FOR 1994 ----------------------------------------------------------------- HEYWOOD WILLIAMS . . . . . . . . . . 407p KENWOOD APPLIANCES. . . . . . . . . . 360p SMITHKLINE BEECHAM . . . . . . . . . .404p GENESIS EMERGING MARKETS . . . . . . .dollars 32.25 FOREIGN & COLONIAL ENTERPRISE TRUST . .71p AEGIS . . . . . . . . . . . . . . . . .17.5p REED INTERNATIONAL . . . . . . . . . .896p -----------------------------------------------------------------

----------------------------------------------------------------- WHAT HAPPENED LAST YEAR ----------------------------------------------------------------- 31 dec 92 31 Dec 93 Change % ------------------------------------------------------------------------ Blue Circle 199.0p 337.0p +69 Compass 518.0p 678.0p +31 Grand Met 465.0p 475.0p + 2 Merrydown 255.0p 220.0p -14 Tomkins 256.0p 234.0p - 8 Yule Catto 240.0p 262.0p + 9 WPP 47.0p 89.0p +89 Portfolio gain +25.5 FT All Share 1,358.06 1,685.3 +24.1 -----------------------------------------------------------------

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