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After a difficult 12 months, Aim looks set to surge once again. We select five stocks with potential

In 1999, London's IPO platform was the best performing market in the world, increasing by a magnificent 142 per cent and winning the plaudits of investment gurus everywhere. Small companies were awarded fancy premiums due to the perceived notion that their prospects in a rapidly changing economy were infinitely more attractive than the dinosaurs on the Full List.

The story last year, as everyone knows, was somewhat different. As TMTs tumbled and incubators crumbled, Aim endured a torrid time, falling by 25 per cent and recording one of the worst performances of any index in London. In the stampede to investment safety, investors decided that Aim ventures should be severely discounted due to the 'inherent' risks associated with smaller companies.

Underlying strength

At face value, the message transmitted to investors by this schizophrenic track record is obviously very confusing. Until, that is, you realise that behind the headlines, the junior market has been undergoing significant (and positive) structural changes during this period of volatility. Indeed, according to the experts, the underlying trends and changes at Aim should make investors view the junior market as the place to chase investment gains.

One committed fan is Peter Ashworth, of broker Teather & Greenwood, who, despite the present gloom, remains more optimistic about Aim constituents than fully-listed companies this year. Says Ashworth, 'I don't think that Aim will replicate last year's [25 per cent drop]. You have to remember that Aim is doing its job. There have been over 80 transfers from Aim to the Full List and more in the pipeline. Crucially the appetite for new issues is still strong. There is a score of VCTs (venture capital trusts) raising cash which is good news for new issues. It should drive the market forward'. Last year VCTs raised over £300 million, a figure that is almost certain to be surpassed in 2001.

Dru Edmondstone, of broker Durlacher, is another stressing the health of Aim's new issue market. Says Edmondstone: 'although it is unlikely that we will see the 254 new companies we witnessed last year, I am quietly confident. I would expect around 150 new companies. Furthermore, I would expect the fundraisings to get bigger. I wouldn't be surprised if 30-odd companies raised more than £10 million'.

If the institutional funds and the fundraising firepower is alluring, so is the increasing interest from the blue-chip securities houses.

Aim flotations used to be the preserve of the smaller, independent broker with specialist knowledge of the smallcap scene. But not anymore. Despite the fact that the market fell last year, an increasing number of large securities houses have muscled in on the Aim action. For instance, investment behemoth Dresdner Kleinwort Benson is now producing research on the likes of AFA, investing in the likes of Softtechnet and acting as broker for Sportingbet.com. There are also rumours that a few large US securities houses will soon be active as nominated advisers and brokers.

Valuation reality check

The other important change for investors is that the whole valuation criteria has improved. The heady, crazy valuations of last year - and the losses many investors endured when the bluff was called - have focused everyone's attention on real value. Says Ashworth, 'there is no doubt that it will now be more difficult to float the kind of ventures that were floated last year. New businesses will need to have more than just a good idea and existing companies will have to prove their potential before being awarded valuation premiums'.

This realism is already in evidence. Those that are launching onto the market are no longer fetching fairy-tale values. One new entrant, software group Intercede, was accorded a realistic valuation of £10 million - less than 5 times anticipated 2001 revenues.

Taking Aim with care

Some bullish analysts expect Aim to start surging forward from March onwards (those with 'reliable' crystal balls are even predicting the market to grow by around 25 per cent). However, in the current climate, the best approach is to judge each company on its own fundamentals. The reason is that, for the foreseeable future, 'divergence' is likely to be the salient feature of the stock market. According to Geoffery Lowery, an analyst at Old Mutual, divergence is likely to be most pronounced in the technology sector. Says Lowery, 'sorting out the wheat from the chaff has never been more important. In the technology sector it is going to be a very mixed year. Technology spend is slowing and software growth is likely to slow. Some companies are going to do very well, but others in the same area are going to struggle - and I wouldn't be surprised if other sectors showed the same trends'.

Northacre - solid asset play

Northacre, a developer of up-market residential property, represents one of the safest investment bets of 2001. The group is currently involved in four major projects in central and west London in which it has strong equity interests (it usually takes a 25 per cent stake in each project). As well as profits on the sale of the developments, it receives a development management fee, plus fees for its architectural and interior design services.

Due to the length of time it takes for developments to be completed (two to three years), its profit streams are often lumpy. However, when they flow, they flow strongly. 1999 was a lean year, but last year the group made a profit (before goodwill amortisation) of £2.7 million in 2000 and is expected to roll out profits of £3.2 million in the year to February 2001.

More importantly, its net asset value per share is around 100p but its shares languish at a mere 36.5p. The discount has perplexed chief executive John Hunter who says 'I can't understand the price. We have three major projects under way, two more than we did when our share price was over 100p'.

If the shares don't improve, there is always the possibility of an MBO - which would almost certainly be higher than the present price. However, Hunter is keen to hatch a different plan to improve the group's ratings. Northacre's management is apparently about to embark on a road show to raise funds for a separate property development fund. The object would be to 'gear up the fund, acquire assets and develop property'. Northacre's board would take a management fee while the group as a whole would 'participate in the profits of the fund'. Whatever happens, buying into the group now seems a sensible policy.

Share price: 36.5p

Market cap: £6.99 million

Online Travel Corporation

OTC is the kind of on-line venture that is likely to thrive once the fear and panic surrounding the dotcoms has subsided. The group's business model is gaining respect, mostly because its customers and its sales are growing, while profitability gets closer.

The group was formed back in 1998, and launched onto Aim in June 2000. The key to the group's success is its ability to build its business via strategic partnerships and corporate deals. As well as operating its own site, all its travel, technology and fulfilment facilities elements are offered to ISPs, websites and other businesses on a revenue-sharing basis. The group now powers or has strategic partnerships with over 40 branded leisure sites including btinternet.com, hemscott and virgin.net.

Just recently it released a solid set of results, showing sales tripling to £33.3 million and the pre-tax loss restricted to £2.9 million. Chairman Alan Judd may have been a bit smug in claiming to have 'reinvented the on-line travel industry', but the group's advances are impressive (for instance OTC's customer acquistion costs are £8.40 compared to a UK average of £51.40).

House broker Durlacher is expecting sales next year to double to £61.6 million with the pre-tax loss forecast to fall to £0.8 million. The year after, £2.5 million of profits are forecast, leaving the group trading on no more than 10 times 2002 earnings of 3.7p. Durlacher's short term target of 95p is ambitious, but the shares could easily double if Judd's plan succeeds.

Share price: 37p

Market cap: £24.2 million

Enterprise

'This is certainly a growth play, just look at the earnings growth of the business' ... so says Stephen Rawlinson, an analyst at Peel Hunt. His comments may be what you would expect from the house broker, but the performance of this support services play over the past year certainly adds credence to the claims.

Enterprise is the result of the August 2000 merger of Arm and Enterprise. Its main business is the project management of cabling and ducting services for telecoms and utilities companies. The group also supplies consultancy and advisory services to local authorities. Since its merger the group has integrated both companies well and is likely to raise around £20 million from the sale of various property interests.

On the operational front, all seems to be going according to plan. Enterprise continues to cultivate strong relationships with its clients and has managed to keep its operational costs at low levels. Most important though, is that it is winning good, cash-generating business (the group has a forward order book of around £600 million). In the 14 months to December, the business is expected to grow pre-tax profits (before goodwill amortisation) to £6.2 million on sales of £59 million. For 2001, profits are expected to surge to £11 million on sales of £135 million while 2002 is expected to see profits of £12.7 million on sales of £150 million. Rawlinson claims the figures are actually conservative and, at present levels Enterprise remains 'undervalued compared to its peers'. On expected 2001 earnings of 10.7p, Enterprise trades off a p/e of just under 12, which falls to 10 on 2002 earnings of 12.7p. With the support services on a historic p/e of 26.3, a re-rating looks justified.

Share price: 128p

Market cap: £82.1 million

Charterhouse Communications

Charterhouse Communications, the publisher of financial and business titles, is currently sitting at 34p, close to what it traded at in late 1999. For many, especially analysts at ABN AMRO, Seymour Pierce and Teather & Greenwood, this presents investors with a good buying opportunity.

The collective bullishness of the experts is due to the fact that the group has expanded its media interests without fail over the past four years, increasing turnover and profits significantly (and consistently) in the process.

Charterhouse now publishes well over 20 magazines (its stable includes the likes of What Investment, Personal Finance, What Mortgage) all of which continue to attract handsome advertising revenues.

It also sports a useful web presence (the moneypages.com), which hasn't guzzled too much cash. In fact, the website has proved to be a valuable marketing tool. Peter Ashworth, at house broker Teather & Greenwood, is also keen to highlight the database of 1 million people who have enquired about the group's products. This has apparently generated 'significant cross selling opportunities'.

The interims for the period to November (due out soon) are expected to show further progress. Excluding any further upgrades on the back of these interims, full year results for the year to May should see profits hit £3.7 million (£2.8 million) on sales of £16.5 million (£9.3 million). Charterhouse is currently trading on a forward p/e of 14.4, a severe discount to the media sector average of 64. Buy.

Share price: 34p

Market cap: £38.3 million

Clarity Commerce Solutions

Clarity supplies an array of software solutions to the hospitality and leisure sector, including electronic point of sale (EPOS) systems, estate management software and customer relationship management solutions.

Its information solutions enable customers to 'manage the flow of sales information', providing valuable insights into sales, pricing, margins, and customer behaviour.

Since launching onto the market at 125p in July 2000 - following a successful £2 million fundraising - the group has performed well, rising from a placing price of 125p to 135p.

Part of the reason for this is that it has delivered exactly what it said it would. The recent interims were bang on target, showing sales of £1.45 million and a pre-tax loss of £370,000.

However, the main reason for its share price resilience is the growing recognition that the group is building up a strong niche position in a growing market.

The group has put its new funds to good use, improving its software offering and increasing its sales and IT staff. It has also been changing its corporate focus, moving away from targeting small single site operations to focus on large multi-site leisure operators. According to analyst Harmesh Suniara, of house broker Williams de Broe, this is likely to increase 'the average size of projects ... and the proportion of revenues generated from higher margin software licence sales'.

The group's clients now include the likes of Belgo, Harry Ramsdens and The River Cafe, while just recently a contract was secured with Punch.

There are strong risks attached to this company (it is still dependent on too few clients and the competition is intense) but the group is addressing these issues while simultaneously gaining an attractive foothold in a market set to increase to £0.5 billion by 2004.

Results for the year to March are expected to see Clarity increase sales to £3.5 million and lose around £800,000 at the pre-tax line. For 2002, Suniara is expecting to see Clarity hit profits of £800,000 (leaving Clarity on an undemanding p/e of 18.2 for 2002).

An added incentive to buy the stock is its takeover potential. Should a large software player choose to enter the hospitality/leisure market, snapping up an established venture like Clarity would make a lot of commercial sense.

Share price: 135p

Market cap: £12.8 million