Shares: Trio with blue-sky horizons

PRIVATE investors are coming back to the stock market, and their return has revived interest in the shares of companies with blue-sky potential.

A lack of earnings can be a positive benefit, making boring calculations of financial ratios irrelevant and allowing the imagination to soar. The key requirement is a good story.

It is early days in the stock market's revival. As a result, there is a shortage of exciting 'stories' for eager investors, which is producing spectacular price action in the few around.

Three I like are Avesco at 86p, Cannon Street Investments at 25.5p, and Tie Rack, which is already back in solid profitability, at 128p.

The excitement at Avesco comes from its subsidiary, Videologic, which makes products for the multimedia market. Avesco itself, specialising in products for the television industry, has been having a tough time. Its recent rights issue to raise around pounds 13m on a one-for-three basis at 63p was accompanied by forecast losses of pounds 1.5m for the year ended 31 March.

But that is irrelevant, given the scope for Videologic. The subidiary has: a joint development arrangement with the industry giant, IBM; a history of turnover growing by over 40 per cent a year to a forecast pounds 10.4m in 1992/93; and more than 10 products at various stages of development that could help sales to climb at an exponential rate in future.

Down-to-earth types look at a market capitalisation of around pounds 50m for a loss-making group and reach for the smelling-salts. But the miracle of price-earnings ratio analysis can soon put that valuation in perspective. Pre-tax profits of pounds 3m would bring the p/e down to 25, even on a notional full-tax charge. Yet if the electronic 'chips' Videologic is developing from the present printed circuit boards become standard equipment in personal computers, they will produce spectacular sales and profits.

This potential reflects the coming together of computer, video, television and audio technology, where Videologic has been developing proprietary products for years. The example is cited of a US company, Creative Technologies, which has products integrating computer and compact disc technology and which is valued on the US stock market at more than dollars 1bn ( pounds 650m) despite comparatively modest sales and profits so far. A demerger and flotation is promised for Videologic, perhaps as early as the end of this year. The top management have an option over 10 per cent of the company and can be relied on to do their best to make it a huge success.

Cannon Street Investments offers blue-sky potential of a different type, with new management striving to resuscitate a fallen giant of the 1980s (and before that a 1970s roller-coaster ride). CSI, which plans a change of name, recently had to pass the dividend on its convertible preference shares and declared a pounds 115m loss. But surprisingly, prospects look reasonable, and the shares have already rallied from a low of 31p. The new team is led by David Smith, who has spent 20 years at the accountancy firm Ernst & Whinney, 10 of them as head of its management consultancy division.

Even before his arrival, much had been done to resuscitate CSI. Debts have now been cut from pounds 100m to well under pounds 20m, against shareholders' funds of pounds 17.8m. After a string of disposals and the flotation of its house-builder, Avonside, the plan is to stick to the core activities of hotels and leisure, electronics and food distribution. Sales are running at more than pounds 170m, and one analyst is looking for 1993 profits of pounds 4m and further progress to drop the p/e possibly to four in three years.

A more proven prospect is the dramatically reborn niche retailer, Tie Rack, where Roy Bishko, the long-standing boss, and the more recently appointed chief executive, Nigel McGinley, have been working miracles in a poor retailing climate.

A US expansion, described as 'attempted suicide' by Mr Bishko, has been brought under control, with overheads slashed, while the combination of a rights issue and cost-cutting (mostly the latter) have turned debts of pounds 9m into net cash of pounds 7.4m over three years.

Last year, profits recovered to pounds 5.1m from pounds 1m the previous year. The group is moving cautiously on expansion, with 25 outlets likely to be added to the present 275 shops. But the value-for-money approach, allied with adventurous design and expansion into related areas like silk waistcoats is paying dividends internationally and in the UK. Operating profit margins of 6.7 per cent should leave room for further progress.