Shares: To keep winning, switch into smaller companies this year

LAST YEAR I went for solid blue chip shares in my nap selections for 1992, with one disastrous exception. The share that bombed out was computer software group Borland International, which ended the year at pounds 13.50 against my selection price of pounds 43.50. Even with that handicap, however, the average gain on the seven shares selected was 13.7 per cent, led by BAA (up 61.4 per cent), followed by Weir Group (up 35.6), NFC (up 35.5), Marks & Spencer (up 13.9), Wellcome (up 8.7) and Grand Metropolitan (up 7.2). The performance would have been improved by following my rule of selling the losing share on a 20 per cent decline, to give an average gain for the seven of 19.4 per cent.

This year, I am spreading the net slightly wider with a selection of eight shares and going entirely for smaller companies. This makes it a riskier list, but that seems appropriate for what could be a lively year in the stock market. It also reflects signs that after years of underperformance, 1993 could be a vintage year for shares in small companies.

The key to prospects is profits. Economists and analysts generally are still downbeat on prospects for both the economy and company profits. But a string of companies have already produced better-than-expected profits, even while the recession has been at full blast. The performance when there is a following wind from economic recovery could therefore be amazing. Two reasons are that UK companies have now been through two intense recessions in the last 13 years, which have made the survivors very fit, and the benefits of the revolution in information technology. Together these influences have transformed the potential profitability of UK companies.

Companies are always interesting when they change their spots. One changing in a remarkable way is the energy company Pittencrieff, which has been using cash flow from oil and gas production, supplemented by share issues, to buy up a string of mobile communications companies in Texas. Expectations are for profits to top pounds 5m this year and possibly reach pounds 8m next year. They could be even higher if the dollar continues to climb. A 1993 p/e of under 12 leaves plenty of room for the shares to rise from 253p.

Shani Group, a manufacturer of clothes for women and children, recently reported a modest increase in profits for the year to July 1992 and expectations of a 'much better' performance in 1992/93.

Help will come from an apparently cheap acquisition in August, which should make a useful contribution. The forecast by Beeson Gregory, the house stockbroker, of pounds 2.5m versus pounds 2m looks capable of being beaten and would still leave a cash-rich group on an undemanding p/e of 10 at 120p.

Aspen Communications at 155p was a 1980s success story that has had a tough time in the 1990s. The group is highly acquisitive and involved in a whole range of media and communications businesses. At the halfway stage, it reported profits down from pounds 1.15m to pounds 920,000, which compares with record profits of pounds 6m in 1989. But chairman Henry Meakin has said in the past that 40 per cent of extra revenue goes straight through to profits and turnover was recently described as improving in each of the group's three main business divisions.

Airtours, the well-known and fast-growing packaged holiday group, feels that its shares are seriously undervalued by investors. It has a point. Floated in 1987, the group has increased earnings per share since at a compound rate of 68 per cent, with even its worst year in 1988 producing a 19 per cent increase.

Percentage increases in the mid-teens are expected this year and next, and the group has a habit of beating expectations. Yet the prospective p/e at 278p is around 10. Statistically, it must be one of the cheapest shares in the stock market.

Among the most spectacular beneficiaries of a stock market boom are fund management groups. None more so than Perpetual at 230p.

The funds the group has under management already stand at a record of over pounds 1bn, and it has had a remarkable run with its unit trusts that has put it at, or near, the top of the ratings. This should make it possible to advertise successfully for new unit holders, who can really bring the money and profits rolling in.

Benson Group at 20p is a miniature conglomerate run by Richard Phillips. It has the advantage of a blue-chip list of institutional shareholders to give it crucial placing power and is making its dash for growth at the perfect time in the late stages of a deep recession.

Pre-tax profits are expected to treble between 1991/2 and 1993/94, and there should be more - and bigger - deals ahead.

Branch networks are expensive when demand is falling but can help profits to soar when conditions improve. The Yorkshire-based Sheffield Insulations is the largest distributor of insulation in the country and has used the recession to acquire rivals and build its market share.

Profits collapsed from a peak pounds 6.2m in 1990 to pounds 1.5m in 1991 but could rebound strongly over the next three years. At 108p, a yield of 6.7 per cent does not discount the potential for a group whose latest interim figures showed that recovery had already begun.

S&U, formerly S&U Stores, makes loans that are collected door-to-door by an army of agents. It is not the most glamorous business but highly profitable, especially when the maximum loan size is on an upward path from pounds 200 to pounds 1,000, bad-debt experience is minimal, and the cost of money is tumbling.

Half-year profits were up nearly 24 per cent, and the p/e on likely profits for the year to 31 January 1991 should be well down into single figures.

(Photograph and graphs omitted)