Aim has been likened to the wild west of the stockmarket. And it’s had a torrid time lately. But there are plenty of good companies out there if you know what to avoid.
This month, the self-proclaimed “most successful growth market in Europe” celebrates its tenth birthday. It’s not the happiest occasion. In the last three months, the Aim index has plunged by 19%, taking it down below 1,000, the level at which it was launched back in 1995. That means that anyone who has stuck with this high risk but high-reward market through thick and thin – and garnered the average return of all of the exciting little growth stocks that have posed and sweated upon its stage – has made less than nothing.
Take a look at the top-ten constituents of the Aim index, and you get an idea why the market has had such a dismal run of late. Neteller and Sportingbet, representing the hot world of online gambling, are joined by retailer Monsoon, investor IP2IPO and the Islamic Bank of Britain. The other five are all from the mining and oil sectors: Peter Hambro Mining, Sibir Energy, Asia Energy, Highland Gold Mining and a company that has just lost 80% of its value and pooped the birthday party in no uncertain fashion, Regal Petroleum.
Does this matter? After all, this is the wild west of the stockmarket and no one invests in every company. There are plenty to choose from. And any investment manager will point to the success of companies such as Majestic Wine Warehouses, Mears, or Peter Hambro Mining, which have delivered returns of 500% or more. Andy Griffiths, who researches all Alternative Investment Market companies for the Aim & Ofex review, claims “it has always been a stockpicker’s market. The majority of companies are not serious investments, with only 100-200 worth looking at.”
But the uncomfortable fact is there are over 1,100 companies on Aim, and the other thousand or so have all gone into somebody’s portfolio, even if they would rather not admit to it. Since its launch £11bn of cash has been raised from investors for Alternative Investment Market companies. This is being trumpeted by the London Stock Exchange and all the professional advisers who have made millions in fees. But are investors joining the Happy Birthday chorus? Only if they have struck very lucky. So, if you want to pick winners, what lessons should be learnt from Aim’s brief history? Here are five:
1. Beware fashionable sectors
Ask a professional to account for Aim’s troubles and he will point his finger at the mining and oil sectors. Such has been the rush for a slice of the action that the number of firms in these two sectors has risen by exactly 100 in the last two years and now stands at 168. With an aggregate value of £11.3bn, it represents 32% of the entire Aim market. And the professionals scorn these exploration upstarts.
But Aim’s poor performance goes much deeper than a little local difficulty in the resource sector. And it cannot be attributed to a general problem with small companies either, because while the Alternative Investment Market index has gone down over the past decade, the FTSE Small Companies index has gained 43%.
Rather, Aim seems to have a penchant for self-destruction. Within three years of its launch, the index had lost 20%, until the dotcom companies gave it a strong tonic. In a glorious interlude, the market rose threefold, with the index hitting its all-time high of 2,924 in March 2000. Once more, though, it sowed the seeds of its own downfall by being a slave to fashion. Dotcom start-ups were drawn to Aim like moths to a flame, investment companies sprung up to buy into them, and the professionals could not resist their allure. One way or another, over half the market was involved in the brave- new technology world. The inevitable happened: by April Fool’s day 2003, the market had lost 81% of its value.
2. Beware the newcomers
So one reason for Aim’s painful progress is that no sooner does a new investment theme capture the public imagination, than opportunists descend on it in droves. Aim prides itself on its light regulatory touch. A prime example of this is that new entrants do not need to show any track record. So it’s all too easy to put together a superficially attractive business plan and flog it to the City. And there’s no shortage of encouragement. An Aim firm needs various advisers, including a “Nomad” (nominated adviser) and, usually, a broker, and nothing stimulates these City types more than the scent of fat fees. These can easily absorb 20%-30% of the new capital raised. And as their promoters can hardly be expected to be unbiased, it is little wonder that the majority of Alternative Investment Market entrants fail to live up to their promises.
3. Beware the opportunists
Charles Breese, who runs Armshare.com, is critical of the City’s new-issue sausage machine. He points out that City sponsors can only cover their large overheads with a string of high charges, and he describes their process of selecting flotation prospects as “bizarre”. Breese reckons that the professional advisers “are more interested in whether company management can present well to City institutions, than in whether they are good business operators”. Only a quarter of companies listing on Aim are “investor ready”, he says, and many new entrants are run by people who have never made any money for anyone other than themselves. In Breese’s view, the process of due diligence fails to answer two key questions: “Is this company’s business model capable of profitability and sustainable growth? And can the management team execute?”
4. Beware broker forecasts
Very few Aim companies are covered by more than the one research analyst employed by their appointed broker. The broker is either on a nice annual retainer, or else may have taken shares or options in the company at flotation. So don’t expect anything negative from them.
Many Aim companies doubt the value of this traditional method of communication. Disillusioned by paying a PR company to prepare a presentation, and then traipsing up to London to deliver it to a fund management junior or a room full of empty chairs, Aim-firm executives are starting to bypass the City altogether.
James Leek, executive chairman of Aim-quoted Torday and Carlisle, has dispensed with broker research. His manufacturing business does not do long forward-order books, so profit forecasts are at best meaningless and at worst a rope by which directors can hang themselves. And he points out that private investors are put at a disadvantage because they do not get to see broker research, or at least not until long after the institutions have had a chance to act upon it. Instead, Leek provides detailed trading statements to all investors, allowing them to judge the prospects for themselves. And he has been rewarded by loyal shareholders and a steadily rising share price.
5. Beware the tiddler
Of Aim’s 1,139 companies, 543 have a market value of £10m or below, implying that the market does not think them capable of achieving a pre-tax profit of £1m in the foreseeable future. This is despite the fact that many of them are paying annual fees of £100,000 or more for their Aim listing – the cost of their broker, PR consultant, Nomad, the non-executive directors, and the LSE’s annual listing fee. This takes a large slug out of their net income and leads Charles Breese to describes Aim as a “market driven by fee generation for advisers and their acolytes”.
But the advisers’ fattest fees come from share issues, and they know that in order to succeed, they only need to convince a handful of City institutions. Many of these will be Venture Capital Trusts, which are obliged to hold the shares for three years in order to qualify for tax breaks. Nobody is required to ensure a liquid secondary market, so with minimal trading in the market it is hard to deal and dealing spreads are prohibitive – 20% or more.
And yet despite all the hazards, Aim is a great place for a private investor to go profit-hunting. There are big winners and companies with infinitely more growth potential than the FTSE heavyweights. And, designed to lure investors to this frontier land, there are tasty tax breaks too. In short: among the Wyatt Earps and Buffalo Bills are some solid and dependable citizens. Invest in these and you will get low-risk investments, and all those tax breaks as well.
The five tastiest stocks on Aim
The opportunity to invest in attractively priced, high-growth companies is not the only reason to investigate Aim-listed stocks. There are also some big tax breaks on offer to Aim investors. Among them is CGT Business Asset Taper Relief. Aim shares are classed as business assets, so if you hold your shares for at least two years, you are only taxed on 25% of your gain, much less than you’d pay for shares quoted on the LSE’s main list. Investors who subscribe for new ordinary shares in Alternative Investment Market companies can also benefit from the Enterprise Investment Scheme. (Qualifying investment up to £200,000 in any tax year entitles the investor to 20% initial income-tax relief on investment, exemption from CGT on disposal, or loss relief if the investment fails or is disposed of at a loss.) But to benefit from these breaks, you first have to find the right small company. Here are five that look very attractive.
Cornwell (update: acquired by Serco May 2007)
Cornwell is a small but highly effective player in a £6.5bn industry – management consultancy. Founded by Keith Cornwell in 1991, it has grown its turnover steadily from £2m to £18m over the last ten years. Unlike large consultancies, such as Pricewaterhousecoopers and KPMG, which are owned by IBM and Atos respectively, Cornwell is not tied to any larger company. This has helped it gain market share and attract new staff. Cornwell is cash generative, it is forecast to make earnings per share of 12.1p and to pay a 3p dividend this year.
Michelmersh Brick
Michelmersh’s (MBH) brickworks in Hampshire dates back to 1842. Business partners Eric Gadsden and Martin Warner spent £5m bringing it up to date before Michelmersh floated on Aim last year. They have acquired brickworks elsewhere, and specialise in the type of high specification, hand-made bricks chosen by architects for jobs such as the redevelopment of the Grade I-listed St Pancras Station. The shares are backed by net assets valued in the balance sheet at 82p. But Michelmersh owns 59 acres of development land at the Blockley’s brickworks in Telford, valued in the balance sheet on the basis of existing use. In fact, Michelmersh has planning permission for this plot, and at today’s £750,000 per acre cost of building land, that doubles the asset value to a figure way above the 90p share price. Michelmersh reported a profit of £1.3m last year and pays a dividend.
Murgitroyd
Chief executive Keith Young describes Murgitroyd (MUR) as a company for those looking for a steady 15% return per year. Founded in 1975 by Ian Murgitroyd, whose family still owns a controlling shareholding, Murgitroyd is a European Trade Mark and Patent Attorney. Driven mainly by Japanese and American multi-nationals, the European market has historically grown by 10%-15% per annum. The profession is populated by older, qualified attorneys, and as they retire Murgitroyd has been able to acquire their business. In January, Murgitroyd bought London-based Patent and Trade Mark Attorney, Castles, in a £3.3m deal that is expected to boost earnings to 13.1p for the year to May 2006. With little requirement for capital investment, Murgitroyd generates free cash and pays a steadily rising dividend. A solid company that is well worth investigating.
Titan Europe
There are few companies on any stockmarket that can match Titan’s (TSW) long history. Wheels have been made on its Black Country site since 1904, and today it is a world-beating producer of steel wheels for agricultural and construction vehicles. Last year’s acquisition of Andy’s has given itaccess to Australia’s booming mining industry, where earthmovers have to be stripped down and overhauled after just 1,000 hours of use. With GKN as its only serious competitor, Titan has a powerful bargaining position, illustrated by its success in passing on the rising cost of steel to its customers, the largest of which is Caterpillar. Earnings per share of 17p are forecast for 2005, and last year’s dividend was 3.75p.
William Ransom
It was in 1846 that William Ransom (RNSM) set up a business distilling natural extracts from herbs and plants gathered from the countryside around Hitchin. The company has only recently moved from its original Victorian premises, asymptom of more radical change being quietly driven forward by 42-year-old chief executive Tim Dye. Through rationalisation and acquisition, Dye is positioning Ransom as the UK’s leading consumer-healthcare business based on natural products. Health Perceptions, a company run by Olympic gold medallist David Wilkie and bought by Ransom last year, recently won Boots’ Vitamin of the Year Award for its Glucosamine product. Last week Ransom announced a £1.5m profit, a 1.5p dividend, and its biggest deal yet – the £23m purchase of aloe vera specialist Optima.
Tom Bulford is editor of Red Hot Penny Shares.
Investing in shares can lose you some or all of your investment. Never risk more than you can afford to lose. Small company shares can be illiquid and carry higher risk than other shares. Past performance is no guide to the future. Consult a financial advisor if unsure. Fleet Street Publications Ltd. 020 7633 3600