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Five go on an adventure

Over the last two decades – blips aside – investors have enjoyed good returns from stockmarket investments. An investment of £1,000 would have grown to over £14,000 today, an increase of over 1,300 per cent.

Over the last five years, the story is rather different, with small gains turning into increasingly worsening losses. If investors want to reverse the trend and again experience healthy profits, a more rigorous approach to stock selection is required.

Smaller companies can offer huge growth potential as they grow faster from their low base than big companies, as can mid-cap companies – an often overlooked area of the market. There will also be times when investment opportunities arise in big caps.

Investors need to take a sensible approach, with common threads being that all stocks selected have a convincing strategy for growth and the shares are valued attractively relative to growth expected. No matter how good the company, every asset has its price, so entry level is important.

This process of sifting the wheat from the chaff is made easier by first identifying areas of the economy which should grow faster than average before selecting stocks which complement these trends.

At Exeter, we have identified five core themes which we believe provide the basis for above-average returns – energy, speciality finance, outsourcing, health, and technology.

Since the oil price collapse in 1986, the world has enjoyed cheap supplies of oil, which has boosted economic growth. The flipside has been that while oil prices have stayed low, it has not made economic sense to find new sources of energy, whether oil, gas or new technologies. Meanwhile, the world economy has kept growing, with a consequent rise in demand for energy.

Energy policy on both sides of the Atlantic is back on the agenda. The US is considering opening the Alaskan wilderness to oil exploration while Britain is aiming to markedly increase the contribution from renewable sources of energy, especially wind power.

In terms of speciality finance, fund management companies are of particular interest, with long-term trends remaining very favourable. In the West, the post-war baby boom generation is reaching the age where earnings are peaking and a desire to invest for retirement is most urgent. This accrues to fund management companies in the form of new business and greater assets under management.

The benefit to shareholders of fund management companies is amplified by the operational gearing of these companies, which is usually high, and balance sheet gearing, which means that earnings can grow much quicker than revenue. In falling stockmarkets, gearing can work against you, so investors should be careful to invest into these favourable trends only if they believe the market is likely to go up and the rating on the shares is not too high.

Outsourcing is an established trend where organisations offer the management, or even ownership, of non-core activities to third parties, thereby allowing them to concentrate on their core competencies.

A much earlier stage of development can be seen in the outsourcing of activities from the public sector to the private sector. Many public-sector services, such as schools, hospitals and the railways, are struggling to provide the services expected of them. The private sector can help by providing extra capacity, access to capital markets for further expansion and cost efficiencies.

Outsourcing can be multi-thematic. For example, in the healthcare sector, Care UK provides a range of non-acute care facilities, working in partnership with the NHS and social services. Its community partnerships division provides specialist elderly care, typically allowing the elderly to convalesce for up to several weeks in comfortable accommodation at a much lower cost than if they had remained in hospital.

The cost of a bed with Care UK is around £500 a week compared with £1,500 a week in an NHS hospital. Care UK&#39s turnover was £81m in 2001, operating in markets estimated to be worth £4.3bn annually, which illustrates the opportunities within the outsourcing sector and smaller companies.

Other healthcare opportunities arise from our ageing population, which is becoming more affluent and more focused on health, as well as a growing realisation that the state will not necessarily finance healthcare entirely. Yet further opportunities exist on the research side, where huge advances are being made with new drugs and technology.

It is tempting to write off technology – a word which now instils scepticism in investors following the boom and bust. But this depends on your definition of technology. In its broadest sense, technology can be viewed as any innovation for which there is potentially vast latent demand that can be unlocked via the development of a new product, rather than the more narrow definition of internet companies, software developers and PC hardware manufacturers.

Investors need to identify companies from the broader range, an excellent example of which is Comeleon.

Comeleon floated on the Alternative Investment Market in December 2000 and provides high-resolution digital imaging applied to three-dimensional objects. Comeleon can embed full-colour images in many materials, including plastic, metal, wood, ceramics and glass. Clearly, this has huge potential and is currently being exploited through the market for replacement mobile phone covers and PC peripherals.

During 2001, Comeleon gained licence approval from Nokia, Siemens, Sendo and Motorola. Through Comeleon&#39s Interactive Design Studio, available at its website, the public can construct their own designs for phone covers, with the completed product despatched to them within days.

The digital imaging of PC peripherals, such as mice, is a perfect vehicle to access the corporate gifts market. Comeleon has signed up Coca-Cola and others will follow. It has already exceeded its operational and financial targets for its first year and we expect this to continue.

There will always be plain good-value opportunities, something which we term reasonably priced growth, where stocks selected do not fit any of the themes mentioned but, nevertheless, have excellent prospects.

Investors would also do well to remember a final category that of recovery stocks, which have potential for recovery growth which could be driven by a pick-up in the company&#39s markets, a refinancing or a new management team.

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