No Pain No Gain: We need those blue chips to keep us in the black

The No Pain, No Gain portfolio spends much of its time hunting in the stock market undercard for its constituents. There is no doubt that little'uns are more exciting and often more rewarding than blue chips which, because of their very size, attract the headlines.

But a portfolio cannot live by small caps alone. It needs a few heavyweights to provide ballast and a more secure dividend income. Since I launched our little share exercise in 1999, I have endeavoured to make sure that at least a few FTSE 350 shares feature in the proceedings. And they have not let us down.

Allied Domecq, the late, lamented wine and spirit giant, is one of the many stock market stars to fall to an overseas predator - departing after a handsome offer from French-owned Pernod Ricard. Safeway, the supermarket chain that has given its buyer, William Morrison, so much indigestion, produced a modest profit, and Six Continents, the old Bass brewing empire that split into InterContinental Hotels and the Mitchells & Butlers pubs group, also contributed to the portfolio's overall wealth when given the heave-ho.

In some ways, I regret elbowing Six Continents. After all, InterContinental and bid target M&B have, despite a succession of share-absorbing capital reorganisations, done well. Still, I suspect most small shareholders would prefer special dividends rather than being forced to surrender shares for cash. Managements like to return cash via a reorganisation or a stock market buy-back. Such manoeuvres help the earnings-per-share calculation, an essential influence in bonus payments.

Stagecoach, the bus and train group, is one that opted for the reorganisation route. It has been a member of the portfolio for more than six years, offering a rather exciting ride, not the more sedate run I would have expected from what is, after all, a blue chip.

However, after the turmoil, the shares settled down and in the past few years performed more in line with expectations. The portfolio paid 80p a share. Imagine my despair when they slumped to near 10p as a multitude of rumours predicted Stagecoach was about to run off the rails. But the stock market often gets it wrong. The shares made a spectacular recovery - reaching 123p; they are around 117p as I write.

On trading grounds, they do not look expensive. Annual profits hit £115m against £104.9m, with the dividend up 12.1 per cent to 3.7p. But there is a worrying shadow over its successful SouthWest Trains franchise. It expires next year and there is no guarantee it will be retained.

As an SWT user, I can vouch for the dramatic improvements it has carried out to what was a shabby service. But, as Sea Containers has discovered, the regulatory regime is unpredictable and Stagecoach faces tough competing bids.

The loss of SWT would be a severe blow. But the group could soften the impact with a significant share buy-back - or even a special dividend. Stagecoach has reduced its activities. The latest cut was the £264m sale of its London buses to Macquarie Bank, of Australia. The London operation is closely regulated and Stagecoach feels happier expanding its provincial network. In the US, where the group had a grief-stricken ride, it is now doing well and looking for takeovers.

But the SWT uncertainty is an inhibiting influence on the shares. So I have decided to play safe by limiting the downside. Consequently, the portfolio will sell if the price hits 100p.

I am in no hurry to unload my other blue chips - Rentokil Initial (156p) and Scottish & Newcastle (509p). The reshaping at Rentokil continues. After disposing of various bits and pieces, it has indulged in a modest buy - increasing its washroom division by acquiring an Australian operation for an undisclosed amount. Washroom services represent some 30 per cent of its global turnover.

Scottish, which is Britain's biggest brewer, should be trading well and there is always the possibility of corporate action.

Finally - Georgica, one of the portfolio's smaller players. The snooker club and tenpin bowling group made it clear earlier this year that it was receptive to offers and last week disclosed that possible predators were circling.

It has, therefore, opened its books to the interested parties but cautions it is "most unlikely that a satisfactory offer will be forthcoming at this juncture". The group did indicate in its earlier statement that it did not expect deals until next year. The shares are around 150p against the portfolio's 87p buying price.

cash@independent.co.uk