COMMENT
Three Fund Manager Favourites

By Ed Bowsher (TMFArkle) (TMF Arkle)
October 25, 2005

Are you looking for new stock ideas? One approach is to find out which are the most successful unit trusts, and then see which shares are owned by those trusts. You can find the top funds at Trustnet, and most funds also publish their top ten holdings on that site.

I've been doing a search through the portfolios of the best UK smaller companies funds. Here are three shares that caught my eye.

Torex Retail

Torex (LSE: TRX) provides software for the retail industry. Its customers include Marks & Spencer (LSE: MKS) and WH Smith (LSE: SMWH).

At first glance, the current share price of 93p looks very attractive. Earnings per share are expected to rise 36% to 9.43p next year. That gives Torex a forward price/earnings ratio of 9.8 and a strikingly low price earnings growth ratio (PEG) ratio of just 0.27. Traditionally, a PEG ratio below 1 is seen as good value.

So why isn't the share price higher?

Concerns about prospects for the retail sector are probably a factor.

Another big issue is that much of Torex's growth is coming from acquisitions. Sales rose 81% in the first half of this year, but only 9% was organic growth. What's more, Torex has bought 8 companies in the last year including a Canadian software player.

Can management successfully integrate these companies into Torex? Maybe, but it won't be easy, and history suggests that buying North American companies is especially risky.

Moreover, many analysts don't like acquisitive companies. Takeovers make it harder for them to figure out what's really going on at a company.

Still, the low PEG ratio means that Torex is worth a look.

Cape

Cape (LSE: CIU) is a contracting business, which largely serves the energy industry. Its services include scaffolding and insulation.

Cape's share price has come a long way in the last three years. It hit a low of 5.73p in 2002, but the shares are now trading at 128p, valuing the company at £106m.

Investors had been worried by potential claims arising from an old asbestos business. Cape, however, raised £33m from a placing earlier this year, and has created a ring-fenced fund which should hopefully pay off most or all of those claims.

The company has picked up several decent contract wins recently including a three year deal with BNFL worth £18m.

These deals have helped to push the adjusted earnings forecast for this year to 16.9p per share. That puts Cape on a price/earnings ratio of just 7.5. Earnings are set to fall to 14.3p in 2006 due to a rising tax charge, but sales and pre-tax profits should continue to rise.

Cape also owns a 120 acre site near the M25, which is valued at £15m, according to broker Evolution Securities.

So there are lots of pluses. The worry is that the asbestos claims will prove to be larger than expected. You also need to bear in mind that Cape is heavily exposed to the booming energy sector - that sector may slow down at some point.

Tanfield

Tanfield (LSE: TAN) has two main businesses - specialist engineering and the manufacture of electric vehicles.

Tanfield recently announced a deal with Dairy Crest to replace 800 of its milk floats, and it also supplies electric vehicles to airport operators. Given growing concern about the environment, electric vehicles would appear to be a business with plenty of growth potential.

Shares in Tanfield are currently trading at 19.5p, which values the company at £35m. It made a pre-tax loss of £3.66m last year, but has now moved into the black, and house broker Daniel Stewart forecasts earnings per share will rise to 3.9p next year. That puts the company on a forward price/earnings ratio of just 5. Great!

The downside for Tanside is that it's only just moved into profit, and Daniel Stewart's forecast may prove to be optimistic. Remember Daniel Stewart is Tanfield's house broker which means it's effectively paid to write analyst research on the company.

So these are three interesting companies to look at. Please do not regard these suggestions as tips. They are purely suggestions for further research. I certainly wouldn't feel comfortable buying any of these shares without doing some more digging!