10 AIM market breakouts from fast moving small-caps

Stockopedia's Ben Hobson finds the small-cap shares where strong momentum is backed up by high quality.

After a sharp fall late last year, the Alternative Investment Market (AIM) has drifted sideways for much of early 2019. But look a little closer and there have been strong gains in some stocks… so what are we seeing?

Compared to bullish moves in the main FTSE indices, the AIM index performance has been pretty unremarkable in recent weeks. That's partly because investors are wary of smaller stocks in volatile conditions. 

Indeed, smaller companies present very particular risks and challenges to individual investors. They can be unpredictable and vulnerable to unforeseen problems. This is why they thrive when the market is risk-on and slide when investors start to fret. 

Sudden swings in sentiment mean that popular shares with strong momentum (that isn’t supported by anything more than enthusiasm) can pull back very quickly when things look uncertain.

One way of tackling this challenge is to look for shares where strong momentum is backed up by high quality. In the Stockopedia lexicon, these are the market's High Flyers - and they're a class of share that can deliver stunning returns.

The hallmarks of a High Flyer

High Flyers have a very distinctive profile. They are good quality, both in terms of their franchise and financial strength. You often see this in high profitability and strong industry leading margins. They’re stable, growing and often have accelerating sales and earnings. They also have strong and improving financial histories and no signs of accountancy or bankruptcy risk.

Added to that, High Flyers have strong momentum both in the price of their shares but also in their track records of earnings growth. It shows up in stocks trading close to their 52-week high prices and performing strongly against the rest of the market. They’ll often be beating broker estimates and getting forecast upgrades and recommendation changes.

The flipside of the coin is that high quality, strong momentum shares are very appealing investments, so these kinds of stocks rarely look cheap. That puts many investors off them.

If you took this High Flyer approach to large and mid-cap companies right now, you'd be looking at stocks like Polymetal (LSE:POLY), Howden Joinery (LSE:HWDN), SSP (LSE:SSPG), Meggitt (LSE:MGGT) and Experian (LSE:EXPN). These companies have robust financial strength and solid performance histories, but their price charts give away just how much the market values these things. The momentum in these shares can be breathtaking.

But what about High Flying smaller companies - and those found on a smaller-cap index like AIM? Well, the answer is that sifting the market for stocks with this kind of profile picks up names that have indeed broken out from the index and - for the most part - delivered some impressive gains. Here are the sorts of companies we're seeing at the moment...

Source: Stockopedia

By their nature, these small-cap High Flyers can appear expensive, and that certainly shows up in the price/earnings (PE) ratios of some of them. But the combined Quality and Momentum Rank scores are obviously very high. Among the names here are the electronic components firm Solid State (LSE:SOLI), toy company Character (LSE:CCT), construction group Watkin Jones (LSE:WJG), rail industry consultancy Tracsis (LSE:TRCS) and footwear retailer Shoe Zone. 

One of the arguments in favour of looking for High Flyers among small companies is that the large companies of tomorrow are most likely to be found in this kind of territory. So, knowing what to look for, and catching these companies early, can potentially offer a big advantage. 

But it's also true that small companies can fail more easily than larger firms, so it's important to be careful. Quality can deteriorate in some businesses, and strong momentum can collapse if the story changes. But paying a higher price for better quality shares on the move is a proven strategy of playing two very powerful drivers of returns in the stock market. High Flyers won't fly high forever, but they can deliver stunning returns over long periods.

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