London’s junior stock market disappointed last year – but a recovery could be due as inflation drops.
The Alternative Investment Market (AIM) is where some of the world’s most exciting entrepreneurs float their shares, allowing British investors to own up-and-coming, as well as established firms, that often fly under the radar of professional stock pickers.
However, the more speculative nature of AIM companies compared with established FTSE 100 or FTSE 250 businesses, means that the performance of the market as a whole has been disappointing – even if there have been some very successful companies to come out of AIM, such as Fever-Tree and Asos.
Since the data begins in 1996, the AIM All-Share index has returned just 11.5%, including dividends. Over the past 12 months (as at time of writing in late January) the index has dropped 18%, even as the market has rebounded 4% so far in 2023. This compares with a 274% rise for the FTSE All-Share since 1996 and 6% rise over 12 months.
AIM’s recent run of poor performance is linked to rising interest rates. Increasing returns from lower-risk investments, such as bonds, means that investors are less drawn to companies that promise future profits but do not make a lot of money today.
AIM is home to lots of unproven firms, with technology and healthcare making up about a quarter of the index, and is generally populated by small companies, as there are no set size requirements to float shares on the market.
James Gerlis, co-manager of the TM Tellworth UK Smaller Companies fund, which can invest in AIM stocks, says: “Since the heady days of mid-2021, when AIM valuation reached 10-year highs, the ride for AIM investors has been a painful one, with most sectors excluding energy seeing significant declines.”
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But dividends are bouncing back from the pandemic, with AIM payouts rising 7.4% in the first half of 2022 to £574 million, according to financial data firm Link Group. The underlying growth rate, which excludes these one-offs, was just under 20% compared with the first half of 2021.
Gerlis notes that the valuation of AIM is now back at 2016 levels, and improving economic conditions have made him more optimistic on the market.
He said: “We take a balanced approach, considering both growthier and more value-orientated investments to give our investors access to the best opportunities we can find – and, with around half the portfolio currently invested in AIM stocks, this market will certainly be a hunting ground for us.”
AIM shares the pros like
One AIM stock he bought last was Team17, the computer game developer. The shares fell 44% last year but have started 2023 strongly, rising 8%.
Gerlis says: “Following a meaningful de-rating, we feel that an attractive pipeline of new game releases combined with the integration of acquired businesses could return the company to the eye-catching levels of growth that were delivered after its IPO in 2018.”
A smaller cap and more value-oriented AIM opportunity, according to Gerlis, is IG Design, where he reckons a new management team will deliver a turnaround.
“Recent updates from the company have already demonstrated signs of improvement – with the shares still trading on a mid-single-digit price-to-earnings ratio, there remains a lot of upside if the trajectory of recovery continues as we expect,” he said.
Gareth Blades, co-manager of the Amati UK Listed Smaller Companies fund, says fewer companies floated their shares and joined AIM in 2022, a sharp reversal on 2021 where there was a lot of activity.
With this negative sentiment set to continue through 2023, according to Blade, AIM companies are still cheap, despite companies’ fundamentals remaining strong.
He said: “We would expect this muted level of new joiners to form a continuing trend in 2023, as negative sentiment continues to weigh on the public market, and while private market valuations catch up with the public market and reset. AIM-listed companies, whose prospects have not deteriorated, and which are poised to continue consolidating their industry position, are now at attractive valuations.”
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Blades likes Craneware, a provider of operational and billing software to hospitals. He says it is well positioned in the current environment as US hospitals come under increasing financial pressure and look to address rising costs.
“Its software allows hospitals to correctly itemise and bill patients, a critical aspect of their business models, which is complex to manage. Software solutions are mission critical to the effective and efficient operation of modern US hospitals. Having started 2022 with a price-to-earnings ratio of 37, it enters the new year at 24,” he said.
He also owns Tracsis, a provider of software, hardware, data analytics and services to the rail and transport industries.
Blades said: “Their suite of products and services promote the increasing use of data and the modernisation of legacy rail and freight infrastructure, such as remote conditioning monitoring for safety, cost efficiency for operating companies, and an improved user experience through pay-as-you-go smart ticketing.”
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The company grew strongly over the last financial year across all its divisions, which benefited from a post-lockdown recovery in traffic data and the return of events such as Glastonbury and the British Grand Prix, as well as multi-year software contracts in its Rail Tech and Services division going live, notes Blade.
It also completed the acquisition of RailComm, a US-based provider of rail technology software and services, which has performed well post-acquisition, winning several large contracts, according to Blades.
Gamma Communications is Blades’ final AIM tip for 2023. It is a provider of communications services in the UK and Europe.
He said: “The company supplies mobile, cloud and broadband services. Despite robust and highly visible revenues, the company has de-rated from a price-to-earnings ratio of 26 to 15.
“It boasts stable margins and cash generation as a percentage of earnings. Cash on balance sheet stands at £73 million, giving scope for accretive merger and acquisitions, as well as investment in the business. While small businesses recognise the need to digitally transform their businesses, they often lack the skills and resources in-house to manage this. This is a structurally growing market for Gamma to target.”
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