By Anna Croze
London’s market for smaller companies is a great talent show for spotting the stars of the future, says Anna Croze. Here, she tips seven Aim shares that have great prospects for the future.
Aim, formerly the Alternative Investment Market, launched 20 years ago. More than 3,600 companies have listed on what the London Stock Exchange styles “the most successful growth market in the world”.
Today it is home to 828 stocks, ranging in size from eastern European residential property developer Kimberly Enterprises, with a market capitalisation of £263,000, all the way up to online retailer Asos, whose market cap of more than £3bn would place it near the top end of the FTSE 250.
Aim allows all sorts of businesses to raise the capital they need to go to the next level and beyond. The risks for investors are obvious, but a diligent approach can yield steadily growing returns. Aim is also favoured by public policy – Aim-listed stocks don’t attract stamp duty, and many also avoid being subject to inheritance tax (IHT) if held for at least two years.
As of last year, Aim shares can also be held in your individual savings account (Isa). Of course, these rules can change at any time – the Conservatives have committed not to raise income tax, VAT or national insurance during this parliament, but tax revenues will need to be found from somewhere. That said, the government is also keen to encourage investment, particularly in smaller companies, and given the recent move to admit Aim shares to Isas, it would seem odd if other advantages were taken away.
How to pick the best Aim shares
So how do you choose a decent Aim stock? Good companies have similar qualities, whether FTSE 100 blue chips or £50m minnows. I look for strong balance sheets, good cash-flow generation, and a decent valuation. Companies must be making some sort of profit. Forget “jam tomorrow” promises – I’ll wait to invest in a company that actually sells something for more than it costs to produce.
As a company grows in value, this sometimes attracts further investors, and more analyst coverage.
For example, four years ago Staffline (more on this below) had its house broker and one other firm researching the stock. It now has five analysts, and its growing market cap means it is large enough for major institutions to build a stake. For those who got in early, such moments can amply reward their faith.
Aim stocks are generally less liquid than those on the main market, so it can take time to build a position, and prices can be volatile. So invest for the long term – five to ten years. Of course, companies change and managements mess up – if the investment case is truly altered, cut your losses and move on. But mostly, it pays to wait. As Aristotle put it, “patience is bitter, but its fruit is sweet”.
Another point on liquidity is that often big stakes are held by management or founding families. These are rarely traded, reducing the “free float” of shares. I normally exclude companies with exceptionally low levels of free float, as it can be hard to deal in very small firms. So I look for a minimum £50m market capitalisation.
As with any portfolio, you must diversify. Some Aim-listed firms have few product lines, or are heavily exposed to one sector or region. This can give them an advantage over sprawling conglomerates, but it also leaves them vulnerable to change, so a portfolio of 20 or more stocks is wise to balance the risks out. I also tend to avoid oil and gas or mining – often these companies have a single well or mine, meaning the outcome is binary. It’s better to buy those odds from a bookmaker.
Dividends are important – they demonstrate commitment from management. As far as I’m concerned, a company needs a good (growth-related) reason not to pay one for me to go near it. And on Aim, dividends can grow fast. Staffline paid a dividend of 7.3p for 2012 when I bought stock at 205p. Now, the dividend is forecast to be 20p in 2015. That’s a near-10% yield on my 205p outlay, and it is set to grow further and faster. Moreover, the dividend is four times covered by earnings.
In short, Aim remains a good hunting ground for investors who are willing to think, analyse and wait for the prey to appear. We have to be willing to accept failure, knowing it will be worth the wait when the successes turn up. Below, I look at seven of the Aim stocks I’m most excited about in the long term.
Anna Croze’s Aim share tips
|Gooch & Housego||GHH|
Kicking the tyres
I have great access to the management of the companies below. You can’t beat “kicking the tyres” for truly understanding a company and its culture and strategy, especially when it is young or on a growth trajectory. Take the aforementioned recruitment and outsourcing group Staffline (Aim: STAF). This has been a great performer, delivering a total return of 555% since I started building a position in February 2012. The management team is fantastic. Andrew Hogarth is a driven, but prudently conservative leader. He was joined in 2013 by Phillip Ledgard as finance director.
Ledgard’s background in bidding for government contracts has stood the firm in great stead, enabling it to win several Welfare to Work contracts. The most recent public service win is a Ministry of Justice contract to provide better support and training to enable prison leavers to find work and reduce reoffending rates.
The shares had a lacklustre run-up to the election, but the Conservative majority surprised markets and reassured investors that programmes to get the long-term unemployed back to work would continue, and also grow to include two million claimants of incapacity payments who are no longer eligible for support. The company’s earnings have kept pace with its capital value, and some astute acquisitions have immediately contributed to earnings.
My next Aim wonder, Gooch & Housego (Aim: GHH), is a photonics business. Photonics is the science and technology of light – it deals with generating, guiding, manipulating, amplifying and detecting light for practical purposes. The associated technologies have applications in industries as diverse as health care, space exploration, construction and the military. Demand for photonics technology is increasing. The global market is worth at least €300bn, and estimates suggest it could double in size by 2020.
With a strong management team and a sound strategy, Gooch & Housego is ideally placed to benefit from this growth. If the management’s goals of doubling revenues and hitting 20% margins by 2020 are achieved, then the company still looks reasonable value, despite its relatively high current price/earnings (p/e) ratio.
Redde (Aim: REDD) operates a group of UK firms providing outsourced motor accident management support, legal services, fleet management and policy fulfilment services for a number of UK motor insurers, insurance brokers and prestige car dealerships. Redde provides replacement vehicles to accident victims who have committed no fault, via a network of accredited repairers and an in-house fleet of around 6,500 vehicles.
Costs are covered by the insurer of the party at fault, and there is no up-front expense to motorists. Redde assesses each claim according to the likelihood of being judged to be at fault, and extends a credit line, secured against the claim, to be settled by the insurer of the party at fault. Any claims rejected by the insurer result in a loss to Redde. So the company has worked hard to build excellent loss-adjustment capabilities.
While it may come as a surprise, Redde also benefits from the recent fall in oil prices. One side effect of lower prices at the pump is that we tend to drive more frequently, which unfortunately also means more accidents. Redde pays out all of its earnings in dividends, resulting in a dividend yield of more than 7%. This will grow, as careful cost cuts continue, leading to an improved operating margin. It also has the potential to grow its legal services division to drive growth in the medium term.
Tape, tech and shredding
Scapa (Aim: SCPA) makes technical tapes, films and compounds with many industrial applications in the construction, aerospace, consumer and car sectors, and healthcare and electronics. This is high-growth, predictable work and it’s also profitable, because it is so specialised. Pharmaceutical firms are creating more transdermal (“through the skin”) mechanisms for drug delivery – from nicotine patches to the delivery and monitoring of insulin. The tapes and adhesives used in these applications are crucial, and the size of the market could be huge. Scapa’s wound dressings are also innovative in an area that has long lacked development.
The ebullient CEO Heejae Chae admits that his company is in the right place at the right time, as the trend for wearable medical applications takes off. Large pharmaceutical companies are outsourcing more specialist manufacturing where possible too, another trend that should benefit Scapa.
At an investor day this month, Scapa showcased the sorts of healthcare solutions that it sells to the likes of GlaxoSmithKline and Roche – the divisional president remarked that the company does “not have a single product, but a quiver of capabilities”. In short, this is a company with fantastic long-term growth potential.
SQS (Aim: SQS) delivers independent software testing and quality management services, which focus on mitigating and managing any technological and commercial risks that might arise through the course of the software development life cycle. For many years, software quality management and testing has been an everyday task, just like software programming or project management. Detecting mistakes early is much cheaper than having to fix errors when software is already in operation – SQS’s mission is to detect software errors as early as possible.
The company is extremely well run. Growth will come from moving to more profitable customers in its managed services business. This work is longer term, meaning revenue visibility is better, and margins are also higher. The business looks set to grow, with recent acquisitions in America and Italy, and I suspect further acquisitions will follow to grow the geographical footprint. The stock trades on a p/e of around 17 – cheap relative to its peers – and yields around 1.5%.
Restore (Aim: RST) has two parts to its business – document management and relocations. Despite our increasingly screen-based lives, there is still plenty of work available in storing, moving, shredding and managing printed documents. Digitising old documents costs time and money – it costs around £150 to scan a 20-inch box of documents, but only £3 a year to store it securely. Restore works in a fragmented market (there are lots of small players) and has a sound buy and build strategy, with acquisitive and organic growth. It also has high earnings revenue visibility, good margins, and strong cash generation.
Sprue Aegis (Aim: SPRP) is one of Europe’s leading suppliers of home safety products, such as smoke alarms and carbon monoxide detectors. Its brands include FireAngel and First Alert. The company should benefit as regulators in a growing number of countries increasingly insist on fire alarms and carbon monoxide detectors being installed in houses.
Sprue is well established in the UK retail market, but there are many opportunities on the trade side to push. For example, new-build houses now need to have mains-powered carbon monoxide and smoke alarms fitted at the point of construction.
Sprue is also able to work together with manufacturers to develop “internet of things” products – smoke alarms that can alert the local fire brigade via Wi-Fi, for example. The company has suffered recently as the weak euro has damaged its sterling profits. This has seen the share price dip, meaning the yield is now nearly 5%. The dividend is twice covered by earnings.
• Anna Croze is executive director of Adam Investment. Nothing in this article constitutes advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or constitutes a personal recommendation to you.
To find out more about investing in technology – from driverless cars to artificial intelligence and quantum computing – sign up to Exponential Investor FREE daily emails and we’ll send you our latest investing report on the tech stocks to watch now. You can view more free reports here.
- Everything you need to know before you buy Aim shares
- Where to find penny shares
- How to buy and sell penny stocks
Category: Buying Aim Shares