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On the hunt for AIM-quoted growth stars
Many investors breathed a sigh of relief after the recent collapse of merger talks between the London Stock Exchange (LSE) and Deutsche Boerse. In particular, it lifted the uncertainty of how a deal might impact on the Alternative Investment Market (AIM).
AIM is the UK market for smaller growth companies. It's been on a strong run since last year's EU referendum, rising in value by around 36%. But it's traditionally been a market that hates uncertainty, and any whiff of trouble tends to drag on prices.
With the LSE's talks with Deutsche Boerse now over, the imminent threat of upheaval has gone. And that's good news for those investors who value AIM's tax breaks and its potential to produce multi-bagging growth stars.
Signs of improving quality
There's a total of 973 UK and international companies quoted on AIM, but in recent years the numbers have been falling.
Some critics argue that reflects a general weakness among the companies quoted on AIM. But others suggest that quality has now taken precedence over quantity.
In other words, the weakest stocks have now gone, and those that are left are generally better quality and are driving up the value of the AIM All-Share index.
According to the latest statistics, there are signs that the trends in companies coming and going from AIM are changing. Accountancy firm UHY Hacker Young says the number of companies leaving AIM dropped by 16% in the last 12 months, falling from 105 in 2015/16 to 88 in 2016/17.
By contrast, the number of companies joining AIM rose by 5%, from 38 to 40. And funds raised in IPOs on AIM rose from £753 million to over £919 million.
UHY suggests that the encouraging numbers reflect the international nature of many AIM companies. Their global exposure has meant they've resisted the turmoil caused by Brexit. At the same time, the market has also benefited from rising commodity prices and growth in tech valuations.
Explosive growth potential
But while the quality of AIM companies may be improving, it's still the case that many are highly speculative and prone to underperforming. Ploughing funds into smaller companies won't guarantee the sort of aggregate return we've seen from the AIM index over the past year.
That's why specialist small-cap fund managers like Gervais Williams and Dan Nichols look for something more. They aim to capture the explosive growth potential of smaller companies by looking for those with positive earnings growth and reasonable valuations.
Taking this approach as a starting point, Stockopedia set out to create a 'growth stars' screen for Interactive Investor. We went looking for companies with positive historical and forecast earnings growth trends.
These measures are brought together in the GrowthRank score, which ranks the growth profile of every company in the market from zero (poor) to 100 (excellent).
This rules-based approach currently tends to favour consumer cyclical and technology sectors. And, be warned, some of these potential growth stars are on rich valuations according to conventional measures of value like the price/earnings (PE) ratio. It perhaps reflects the popularity of smaller growth stocks in the current market conditions.
The list includes some of AIM's most famous growth companies of recent years, such as the fashion retailers Boohoo.com (BOO) and Asos (ASC). Other well-regarded growth companies include the buy-and-build veterinary group CVS (CVSG), and the support services firm Restore (RST).
Hunting for growth stars
It has been a year of super performance from the Alternative Investment Market - helped in large part by some of its better quality high-growth companies. While there's a lot of evidence showing that smaller companies outperform, it's also true that many AIM stocks are high risk.
With potentially weak financial resilience, AIM shares need careful handling. But it's equally clear that investing in AIM companies can produce stunning results. Look carefully and it's possible to find some of the most exciting and dynamic performers in the market.
Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.
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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.
*No fee for publication is involved between Interactive Investor and Stockopedia for this column.
About the Author
Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.