The Investment Column: Easy to construct case for Wolseley

A buoyant housing market, strong global economies and rising steel and copper prices over the second half of 2004 have helped Wolseley, the building materials group, look forward to 2005 with confidence.

The huge demand from China, which is sucking in steel and copper imports to fuel its booming industrial revolution, has pushed up commodity prices worldwide. Bathtubs, pipes, tubes and bricks are all part of Wolseley's product range, which it sells builders and plumbers. The group has been able to pass on raw material prices to its customers and yesterday said commodities inflation had added $10m (£5.4m) to its North American profits alone. Lumber prices were 18 per cent up on the same period in 2003, pushing group sales for the five months to the end of December up 10 per cent and trading profits up more than 25 per cent, excluding currency movements.

But the weak dollar is always an issue for Wolseley, as it derives almost 60 per cent of its earnings from North America. Profits took a £13m hit, but yesterday analysts upped forecasts by about 5 per cent on signs of the group's good organic growth.

Housebuilding in the US has been strong, thanks to low interest rates and low unemployment levels. And government spending on hospitals and schools in the UK is giving continued impetus to the construction sector.

A sharp housing market crash is a risk, though; Wolseley said the market is slowing in both the US and the UK. But there is an acknowledged long-term shortage of residential housing in the UK that will prop up demand, and Wolseley is not reliant on new developments for earnings.

Commodity prices are also expected to stop rising so dramatically. The company believes they will remain at high levels, but this will make comparisons with 2004 figures less impressive.

Still, at 1,047.5p, it is only trading at about 13 times 2005 earnings. Its geographical spread across a number of economies means it is a solid, low-risk business and consequently a core holding.

Child's play wins US deal for Entertainment Rights

Entertainment rights, the intellectual property company behind children's characters such as Basil Brush, Postman Pat and The Tweenies, announced yesterday it had found a partner to distribute He-Man, the cartoon superhero, in the US.

It is not the power of Greyskull (He-Man's magical lair and the source of his talents, for those who don't know the series), but BCI Eclipse, a distributor, that will get He-Man on DVD into the homes of up to 100 million people.

Entertainment Rights bought He-Man and The Tweenies in two separate deals last year, which is making up for the loss of a merchandising contract for Mattel's Barbie in 2003. It still has the rights to Barbie's videos, however, and an array of other children's favourites, which gives the group a cross-section of appeal.

Postman Pat is also branching out. A deal signed with Nickelodeon yesterday will put him on air in Belgium, the Netherlands and Scandinavia. The BBC is committed to the show, as it is with The Tweenies. The company now has 1,800 hours of children's entertainment programming and cracking the US market is key for 2005.

Readers who stuck with the shares after the Barbie contract-loss have seen their shares double. With huge potential in the US, there is still room for more growth to come. Buy.

Big profits may still be found in the small caps

ABN Amro put out its coveted 2005 small cap sector outlook yesterday, predicting a slower year of growth for smaller companies after two years of record returns.

Having outperformed larger stocks by some 7.5 per cent last year, and having delivered total returns of more than 20 per cent, small cap equities have been among the best performing asset classes in recent years. Although ABN believes company valuations do not yet look too stretched, it predicts that 2005 will at the very least see smaller company returns come back into line with those from the larger end of the market.

Despite a predicted slowdown, the bank believes there are still a handful of strong stocks that have the potential to dazzle.

The most recognisable of names in its 2005 portfolio is Mothercare. After a ropy few years during which the group went in to the red, ABN believes this stock now promises to be one of the few shining lights in the small cap retail sector this year.

At the smaller end of its stock picks is Chloride, the electrical support services group, which provides emergency power services to a raft of different industries. The cash-generative nature of this business, coupled with its 3.7 per cent dividend, are two reasons why ABN rates it as one of this year's potential leaders.

Sector-wise, ABN favours real estate, construction and engineering.

If you are investing for the long term and have some appetite for risk, small caps remain the way forward. Over the last 50 years, they have delivered annual returns of 16.2 per cent, compared to just 12.7 per cent in the FTSE All-Share.