AIM: basket case or treasure trove of hidden gems?
AIM is often regarded as a poor-quality market, filled with small, early-stage and highly speculative companies, which have disappointed investors year after year.
Is this an empty prejudice or an accurate, if a bit simplistic, description of the reality?
The answer, as is often the case, lies somewhere in the middle.
Consider size, first.
The average market value of the 1,013 companies currently listed on AIM is £70 million. However, there are 173 companies worth over £100 million and five worth over £1 billion. The largest, online fashion retailer ASOS, has a market cap of over £3 billion.
Now let’s look at performance.
First, a caveat. AIM is a moving beast. Its constituents change regularly, so simply looking at the index performance will not be very informative.
Indeed, over the past two decades, around 3,000 companies have listed on AIM. Nearly three quarters have never produced a positive return for investors, according to research by the London Business School. Almost one in three has lost investors 95% of their money.
At the other extreme, 39 companies have produced returns in excess of 1,000%.
What does this demonstrate?
In my view, it shows there are opportunities, but only if you know what you’re doing. In other words, it’s a ‘stock picker’s market’. Experience is definitely vital to success.
Anecdotally, most of my own AIM stock picks have been disastrous. However, when I’ve left the stock picking decisions to a professional manager, I’ve been very happy with the performance.
I’ve asked a few managers to give us examples of the kind of company they invest within their portfolio.
Octopus AIM Inheritance Tax ISA and Octopus AIM Inheritance Tax service
RWS Holdings plc has been a longstanding holding in the Octopus AIM Inheritance Tax Service portfolios as it has grown steadily to its present position as the world’s leading independent patent translator. Clearly a niche market, but it is one which requires detailed accuracy and very high levels of technical understanding and RWS has become a world leader. In this respect it is not alone in AIM. While its name is not as well-known as, say, Google, there are many world leaders with shares traded on AIM. Such companies tend to have a long history of profitability, growth, cash generation, dividend payments and a consistency in the management’s approach to running the business. All those characteristics go to help reduce the risk in the investment and explain why Octopus continues to like RWS. It first bought shares in 2005 at the equivalent price of 37.2p, when the company had reported revenue in the year to September 2004 of £31 million and equivalent earnings per share of 1.62p. For the year to September 2015 revenue had grown to £95.5 million and earnings were 8.1p per share. The dividend has also grown from 1p to 3.85p per share. This remains a high quality company in a growing market (there will be no shortage of patents needing translation in the foreseeable future) and Octopus continues to like the prospects for the next few years.
CVS Group plc was established in 1999 to acquire and operate veterinary practices. It is now the largest veterinary group in the UK. The company operates over 350 surgeries, 4 laboratories, an online dispensary and 7 pet crematoria. Octopus started buying the holding for new clients in August 2009 when the company had £76 million of revenues, £4.4 million profit, 168 surgeries and just one pet crematorium with a share price of 117p. For 2016 the company’s broker forecasts the company to generate revenues of £217 million and £24 million of profit before tax. The share price is now over 800p. Although the company is relatively unusual in the Octopus AIM Inheritance Tax Service portfolios, as it has debt on the balance sheet, this is well managed as the company is very cash generative. As a result, debt is expected to fall sharply over the next two years, despite the company continuing to build its network and invest in its surgeries. Octopus likes the generally economically resilient nature of the business, proven acquisition history and strong management team. The Chief Executive has been at the helm for 11 years. With just 6% market share there is still much to go for and Octopus expects the company to continue to grow its profits from here.
Renew Holdings plc is an engineering services group supporting UK infrastructure. The company is focused on the key markets of Energy, Environmental and Infrastructure, with nuclear decommissioning, rail and flood alleviation being among its core capabilities. Octopus started buying it for its AIM Inheritance Tax Service portfolios in early 2008 at a price of 97.5p. Since then the company has grown profits from £9.5 million on revenues of £390.6 million in 2008, to profits of £19.7 million on revenues of £520 million for the year ended September 2015. Over that same time horizon, the dividend has grown 133% and is expected to be increased a further 14% this year. Given the nature of Renew’s activities, the business enjoys great revenue visibility. In the energy market, Renew has been awarded a position on the Decommissioning Delivery Partnership framework for Sellafield, a 10-year framework agreement that's an essential part of the site's long-term decommissioning, which could be worth as much as £1.5 billion. At the interim results, the order book was up 9% to £515 million, meaning all of the company's second-half revenues are already secured. Broker forecasts expect the company to deliver profits of at least £21 million from revenues of £524 million in the 12 months to end September 2016, with a strong net cash position of £6 million.
Downing AIM Estate Planning Service NISA and Downing AIM Estate Planning ServiceAccumuli
In 2010, Downing made a follow-on investment into legacy holding Accumuli PLC, a network security software provider with a £12m market capitalisation at the time. The managers were attracted to it because of the increasing demand and a compelling combination of the company’s margins, growth profile and modest entry price. True to their process, the team was very hands on. It worked alongside the management to appoint a new CEO, as well as an executive chairman with relevant industry experience. It supported Accumuli in the acquisition of three companies in the network security sector. In 2015, Accumuli was sold to NCC PLC, yielding a 417% return on the monies invested in 2010, and an IRR of 47% over this period (source: Downing LLP, based on data from Downing One VCT and MI Downing Micro-Cap Growth Fund OEIC). Please note, past performance is not a reliable indicator of future results.
In late 2015, Downing invested in Conviviality Retail PLC. The company predominantly operates under the ‘Bargain Booze’ and ‘Wine Rack’ brands and owns the UK’s largest franchised off-licence and convenience chain, with more than 600 stores. Downing opted to participate in the placing that was arranged to fund the acquisition of Matthew Clark, the UK’s largest independent wholesaler and distributor of alcoholic beverages. Having met with the management on a number of occasions prior to the deal, Downing was impressed with their calibre and the opportunity to grow Conviviality into the UK’s largest retailer and distributor of alcoholic drinks. The expectation was to generate material synergies and improved margins, and to increase the market share to generate top line growth. A modest pre-deal rating and an attractive, well covered dividend yield helped to manage risk. Downing had the added advantage of being able to draw on the investment expertise of our unquoted team who have experience in the public house sector.
Unicorn AIM Inheritance Tax Portfolio Service (outside an ISA)
Unicorn AIM Inheritance Tax Portfolio Service (inside an ISA)
Unicorn’s philosophy is to invest in companies for extended periods. In an ideal world, it aims to partner with investee businesses for a minimum of five years.
One such example is Abcam – a global leader in the supply of innovative protein research tools. It manufactures and distributes antibodies to medical research. It holds a leading position in a niche market, has a strong record of organic growth and an experienced management team. It is also a truly international business, with the majority of its revenues being dollar denominated. Importantly, the company has strong underlying fundamentals being cash generative and debt free. Unicorn has been continuously invested in the business for over 10 YEARS and has seen it go from strength to strength. At the time of the original investment, the market cap of Abcam was £57 million, whereas now it is more than £1.5 billion.
Another example is James Halstead, a commercial flooring manufacturer, serving the domestic and global markets. Founded over a century ago the company has delivered 40 years of consecutive dividend growth. The Halstead family retains a significant stake in the business, which is a major positive in the manager’s opinion.
ULS Technology, a provider of online technology platforms primarily for the UK conveyancing market, recently released a strong set of full year results. The business is selling its conveyancing software to an increasingly wide network of mortgage lenders and intermediaries. The cash flow generated from this expanding revenue stream is allowing management to invest significantly in new product development. Furthermore, the particularly strong cash generation has enabled the Board to return £1.8 million in dividends to shareholders, while net cash balances have grown to £2.9 million.
Photo credit: Sam Valadi
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