Quality AIM stocks that are resisting market pressure

Ranking the quality and momentum of every AIM stock reveals 10 high-flyers worth watching.

Pressure on prices this summer has dragged the Alternative Investment Market back to lows not seen since the market slump late last year.

The growth company index is currently trading around 10 percent below its 2019 high, which it hit in early May. With so much uncertainty around, it’s understandable that some will be wondering whether this is a mere blip or the start of something serious.

Given its riskier nature, AIM tends to be sensitive to investor sentiment. Growth stocks sell off quickly when the market senses trouble. But some shares are better at resisting this kind of pressure than others - particularly higher quality ones.

Last month, research by the advisory firm UHY Hacker Young revealed a consistent trend towards higher quality shares on AIM over the past 10 years. A decade ago, as the market was beginning to recover from the financial crisis, 275 companies came off the AIM market. Last year, that number was just 66, with very few blaming onerous regulation or high fees which have historically been the main drivers of delistings.

Another interesting figure is that the average market cap of an AIM stock has risen nearly four-fold over the past decade to £98.9 million in 2018, up from £24.3 million in 2008.

Those averages will be skewed by some of the very large groups that have emerged on the index - Boohoo (LSE:BOO), Fevertree Drinks (LSE:FEVR), Abcam (LSE:ABC), Hutchison China Meditech (LSE:HCM).  But of course, big doesn't necessarily mean safe. Burford Capital (LSE:BUR) was up there as one of the largest-cap stocks on AIM until recently - before the recent 'bear attack' that slashed its share price.

Hunting for quality and momentum

So where should investors start looking for higher quality names with the strength to fend off brief spells of volatility? One answer is to look for those with the strongest blends of high quality and strong price momentum. 

These kinds of high flying shares are very distinctive. They are good quality, both in terms of their franchise and financial strength. This tends to show up 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.

In addition, higher quality, positive trending stocks 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 outperforming the market. They’ll often be beating broker estimates and getting forecast upgrades and recommendation changes.

The catch with high quality, strong momentum shares is that the market loves these traits. As stocks these high flyers can appear expensive, and that can put many investors off them. Only with hindsight could you say they were a bargain.

Using Stockopedia's algorithms for calculating and ranking the quality and momentum of every stock in the market, here's a top 10 list of AIM stocks that score well on both counts...

Source: Stockopedia

The one year relative price strength in these stocks reveals that most have done very well against the market over that time. Companies like the software firm Sanderson Group (LSE:SND), tableware group Churchill China (LSE:CHH), IP service specialist RWS Holdings (LSE:RWS) and healthcare IT company Instem (LSE:INS) have all seen their shares outperform.

A hallmark of these firms is that they have strong quality characteristics - illustrated by strong returns on capital - but comparatively high PE ratios confirm that they are also in demand.

The appeal of searching out higher quality, strong momentum stocks is that it focuses on parts of the market that can be more resilient to price pressure. High flying smaller stocks can be a hunting ground for finding the successful large companies of tomorrow. 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.

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