Smaller Companies: Go carefully into computers

First, a health warning. The dream is to find a decent small company and watch your investment grow as the company grows, writes Richard Phillips.

The reality is often not much different from investing in blue-chip stocks. Unless you are ruthless in your investment decisions, occasionally lucky, and willing to put in the hard work, the result is often a share that performs no better than the market as a whole. More likely still, an initially appealing investment turns into a disaster. The observation that it is exceptionally difficult to beat the market average has been statistically tested so many times, it is pointless to debate it.

While prospective investors reading this column should find the odd gem, you should also make your own investigations.

The reason for this lengthy preamble is that this week's choice is Northamber - a small concern in that most volatile of sectors, the computer industry. The business, a distributor of computer hardware and peripherals, has been around on the stock market since 1984 - long-term followers will recall that from its flotation at below 40p, the price soared to touch pounds 2 in 1988, before plunging to a low of 10p by late 1992. Since then it has made a strong recovery, to 147p, with most of the gains coming in 1995. Despite this, there are fans out there who believe the shares are seriously undervalued. As Mark Loveland, of stockbroker Dresdner Kleinwort Benson (not, it should be noted, the company's house broker), points out in an enthusiastic recent research note, sales and earnings per share growth could average 12 per cent and 15 to 20 per cent a year respectively over the next three years. If that were to be true, then the shares are seriously undervalued, trading only 8.7 times current year forecast earnings. A more realistic valuation urged by Mr Loveland is 235p.

The question investors need to ask, however, is why the company has failed to grow pre-tax profits in any significant way over the last 10 years. In 1989, pre-tax profits were pounds 6.16m. Last year it filed a figure of pounds 5.57m, after hitting the buffers in 1992.

With chairman David Phillips owning 50 per cent, management looks set to remain in the same hands for some time.

The company has formed close relationships with its suppliers, and the industry boom can only boost its prospects. It is also catching more high- margin business by helping manufacturers install and configure software on certain systems, as well as doing the final assembly work on some lines.

There are good reasons for the shares to continue making progress. But remember the maxim: once bitten, twice shy.