The Private Investor: 'There's a surprising amount of money to be made in the middle'

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The Independent Online

It is such an obvious idea, but that does not make it a bad one. Looking more attractive by the day as the market picks up steam are shares in the small and medium-cap brokers. They jogged my attention this week with some excellent recoveries.

This thriving little sub-sector includes Charles Stanley, Evolution Group, Shore Capital, Numis, Teather & Greenwood, Close Brothers and, of course, Collins Stewart, one company over-shadowed by the public dispute with a former analyst accusing it of breaching regulations.

Geared as they all are into secondary market trading volumes, the brokers' share prices were marked up by the market makers in early summer as those volumes rose.

That was when confidence grew that trading sentiment would stay positive. While they have reached 12-month highs, the shares are still a long way below their peaks. And they have the advantage of being fairly transparent: it is possible to get a good handle on their business levels by watching trading volumes and announcements of initial public offerings of company shares.

Speciality finance, in which these brokers star, has been the top sector when it comes to upgrades over the past year. E*Trade Financial reckons earnings should rise 15 per cent this year, and 39 per cent next year as reviving market activity really kicks in.

Corporate finance business has been transformed because the major investment banks, such as Deutsche Bank or Citibank, will hardly look at transactions where the fee is less than £1m. That disenfranchises most small- and medium-cap companies, who have been left to find new brokers. This has given a tremendous boost to the specialist brokers, who rushed to pick up the best earners.

Retainers paid to brokers by companies for a regular market service and advice have gone up three-fold from the annual £20,000 or so of a couple of years ago. And placings of shares earn higher rates, too, at 4 per cent these days.

Later in the market cycle to recover is private-client business, but that has just begun to turn. There is lots of scope here for making money, because private investors have grown highly sceptical about investment products, as opposed to straight equities, since the investment trust and pension fund scandals.

First away this week was Evolution Group, which announced its interim loss per share had been cut from 2.9p to 0.6p. But analysts say that figure should be up to earnings of at least 2.7p by the year end. There is also a potential bonus from Evolution's 75 per cent stake in IP2OPO, the joint venture with a number of universities which is commercialising intellectual properties.

Conservatively, a figure of £48m has been put on this hi-tech business, but that could easily rise to £60m. Evolution said it will float IP2IPO, or take value in some other way. It is extremely upbeat on its corporate finance activity, and says private-client fund management is reviving again.

Shore Capital boosted interim profits from £33,000 last time to £343,000 and should have a strong second half. It has taken on the core of the former Charterhouse research, sales and corporate finance teams at a high cost.

Charles Stanley managed to stay in the black last year, despite the slump in equity markets and its involvement in the split-capital trust mis-selling scandal. It is forecast to produce earnings of 7.95p a share in the coming year, followed by 9.55p.

Numis has won an impressive investor, the City entrepreneur Michael Spencer, who is also chief executive of the inter-dealer broker Icap, and an insider in the nicest way. He took a 10 per cent stake in Numis in April, which should be a good enough signal for other investors if, as expected, the market rally continues.

Collins Stewart's expansion has been more aggressive than most. It is expected to boost earnings per share from 26p for 2003 to over 30p next year.

All the signs are that this little sector should continue to prosper as the stock market gathers momentum. It is a good way to bet on the market recovery.

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