Building an AIM portfolio: stock selection

In the second part of his look at the AIM market, Chris Boxall, director and co-founder of Fundamental Asset Management, considers how to choose AIM stock.

Building an AIM portfolio: stock selection

Successful long term investment on AIM, the London Stock Exchange’s (LSE) international market for smaller growing companies, has generally been achieved by avoiding the more speculative companies on offer and focusing on better established, profitable and cash generative businesses, typically headquartered in the United Kingdom.

It’s generally been about steering clear of the ‘story’ stocks with their promise of huge riches and investing in profitable, cash generative businesses that are easy to understand. Prudent, thoughtful, patient (some might say boring) investment of this type has generally paid off, however, there are exceptions.

AIM success story

One of AIM’s greatest success stories has been ASOS, the online fashion and beauty retailer. This highly valued business joined AIM in June 2000 with the forgettable name of ‘As Seen On Screen Holdings plc’, raising a modest £225,000 at 20p per share with the resulting market capitalisation at the time only £12.3m. The main concept for the business back then – and it was a concept – was to source and sell products to consumers that were showcased in film and/or television programmes as well as by celebrities. ASOS’ turnover in the six month period ending 30 June 2001 was only £466,000.

While ASOS was loss making at the time, and remained very much a story stock, the idea was relatively easy to understand, especially if you were a party-going teenager. And with online retail set to boom it brilliantly took advantage of its opportunity. Clearly few people believed it had much of a future as the share price had slumped 85% by August 2003. Those brave enough to have invested a mere £3,000 at this point would have seen their investment balloon to over £4.5m now, assuming they hadn’t taken profit along the way!

However, ASOS has very much been a glorious exception to the idea that story stocks can deliver, with the vast majority of concept stocks having consumed cash and disappeared. While better established businesses with proven business models may not have delivered ASOS type returns, many have delivered terrific growth far exceeding main stock market peers.

Avoid the value traps

A seemingly boring AIM company should still have strong growth prospects, so please don’t think this advocates investment in low-growth plodders!  Investors seeking apparent value from some of AIM’s better-established but unloved AIM companies that are struggling to grow, have often been left disappointed. An anticipated recovery never materialises and the company remains stuck in investment limbo with little shareholder interest.

Unless there is a clear catalyst for change, such as new management, these types of low-growth AIM stocks should often be avoided, particularly where a dominant management shareholder is essentially running it as his/her own private company. Furthermore, the shares are typically very illiquid and therefore very hard to sell.

Volatility psychology

Even the best businesses have periods of underperformance and when this happens to a small, less liquid, AIM company the effect on the share price can be dramatic, as investors indiscriminately sell shares forcing the share price down.

Double digit percentage declines (and rises) in share price are common place for AIM companies, often for no clear fundamental reason. It can often arise simply because a large institutional shareholder needs to sell at a time where there is little large buying interest from other investors, with the result that the share price nosedives.

Private investors can be greatly unsettled by this kind of extreme volatility and exacerbate the situation by in-turn selling themselves. The situation is even more dramatic if a large percentage of the investor’s AIM portfolio is made up of shares in a single company that subsequently disappoints or sees its share price fall dramatically.

It is for this reason we advocate reasonable diversification when investing in AIM to avoid the sleepless nights that come with portfolios that are over exposed to individual companies.

It should always be remembered that many AIM companies are small and growing very rapidly. Many of the high flyers also often trade at relatively high valuations that leave little room for error and demand they continue to exceed broker forecasts. Many of these companies also possess relatively simple, business models and therefore it doesn’t take much for the business to suffer a short-term slowdown. While this slowdown may not be permanent the resultant share price reaction can be dramatic.

Specialist AIM investment managers generally adopt a diversified approach, spreading investment across a larger number of AIM companies with different industry exposures.

Sufficient liquidity for most private investors   

Investors are often concerned about the difficulty of selling AIM shares. While AIM shares are less liquid than blue chip stocks, unless portfolios are very large (£1m plus) it should be possible to liquidate a well-diversified AIM portfolio relatively quickly, assuming normal market conditions.

Investing in AIM quoted companies can be highly rewarding but it demands considered research and portfolio management. Those investors that remain rational in the face of greater volatility will benefit from the irrational behaviour of others.

 

The first part of the series was published yesterday and can be found here:

http://everyinvestor.co.uk/2017/02/02/reasons-for-building-a-portfolio-using-aim/

 

Chris Boxall is director and co-founder of Fundamental Asset Management.    

Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest. 

 

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