Promise of high returns as small cap market flourishes

Small investors can have the advantage with Aim shares, says Nick Clayton

Every investor dreams of making a killing with shares that double or treble their value over a very short period. It does happen, but hardly ever with any company that qualifies as a household name. The spectacular gains come from small unknown companies.

Every investor dreams of making a killing with shares that double or treble their value over a very short period. It does happen, but hardly ever with any company that qualifies as a household name. The spectacular gains come from small unknown companies.

This boils down to simple mathematics. If I have a £100 holding of shares worth £1 each and they rise in value by 1p, my portfolio is worth £101. If, instead, my £100 goes into shares worth 5p each and they rise by 1p, my investment is worth £120. Of course the flipside is that a 1p fall in the value of those cheap shares will create a far bigger dent in my finances.

Despite the obvious risks many investors are attracted by the chance of making spectacular gains and, with a balanced portfolio of generally safe stocks, there may be room for something a little more speculative. The question is where to look.

"According to research, small companies outperform large companies over the long term. Aim is the small cap market of the London Stock Exchange and, after a hesitant start, has become a flourishing market," explains Clem Chambers, chief executive of European stocks and shares website ADVFN.

Aim was launched in 1995 to allow new and growing companies to float without the tight restrictions of a full Stock Exchange listing. Aim members do not have to be above a minimum size or supply proof of a lengthy trading history. They also do not have to ensure a quarter of their stock is in public hands. The idea is to provide businesses with the experience of being a public company before making the leap into the full market.

That does not mean that all the companies listed on Aim are new, small and unknown, although most are. But it also includes football clubs such as Tottenham, food chains and such as Domino's Pizzas.

Aim companies still have to supply information which could be of value to potential investors. Audited accounts have to be filed within six months of year end. Anything that might materially affect the share price has to be reported to the Exchange. And before the company floats it has to appoint a nominated advisor and publish a detailed public prospectus.

This information should be just a starting point for anybody thinking of putting their money into an Aim company. These are, however, shares where small investors can find themselves at an advantage over professionals from the financial services. Many Aim-listed businesses operate in niche markets and, because of their size, they are not always that well researched. It is possible to find companies that are under-valued.

"Private investors love small caps because they represent a promise of high returns and exhibit exciting volatility. Because of the Market Maker system with its large spreads on small cap companies, the cost of buying and selling an Aim stock can be very high. In addition, you cannot put an Aim stock into an ISA," says Mr Chambers.

"But the right Aim stock will outperform big cap stocks as small growing businesses can multiply returns much more easily than huge companies. Aim stock also qualifies for taper relief, which means after holding one for a couple of years capital gains tax drops to 10 per cent, a benefit that companies on the main list do not benefit from."

In general, though, Aim shares are no different from any other. Getting the returns you want is a matter of using your knowledge to assess which shares to buy, when to buy them and how long to hold onto them.

"I don't really distinguish between Aim stocks and others. Often the main reason for a company choosing an Aim listing is because a full listing is so expensive," says Paul Mumford, fund manager at Cavendish Asset Management.

For anybody thinking of building up a portfolio of Aim stocks, Mr Mumford recommends reducing the risk profile with detailed homework. Investors should look for a strong balance sheet, decent management and a reasonable profit performance, the same as for any other stock purchase.

"If you are making a highly speculative investment, it is no use having just four or five stocks," he says. "You really need 20 or 30, otherwise you stand a serious risk of being wiped out."

Those waiting to invest should know that Aim shares are bought and sold in the same way as any other share, through a stockbroker. It can be more difficult to acquire shares in a chosen company because the volumes traded are low and there tends to be just a handful of brokers dealing in them.

Investing in any "small quoted company" is inherently risky. Prices are volatile and can fall rapidly under adverse conditions.

A "buy" recommendation from a broker, newspaper or tip-sheet can send the price soaring. But that lack of liquidity can make it difficult to realise a profit when selling rising shares or escape a loss as they fall.

If the risks are great, so are the rewards. Small, new companies have much greater potential for growth big FTSE 100 companies.

A well-informed small investor can beat the brokers. Most professionals feel it isn't worth keeping an eye on companies with a market capitalisation of less than £100m. The average value on Aim is £22m.

Investors should also take stock tips with a pinch of salt, whether they come from specialist "tip-sheets" or newspapers

And keep a broad portfolio. Holding shares from just a handful of small companies is too risky.

* DOBBIES

What it does: Garden centre operator

Floated: March 1997

Market cap: £44.3m

Why it's a good buy: Alan Titchmarsh, Charlie Dimmock et al have made the British gardener as fashion-conscious as a teenage clubber. Dobbies has been a major player in Scotland for years and is making a success of moving over the border into England.

It reported a 3.8 per cent increase in profits up to £1.9m for the six months to the end of April while turnover rose by 7.5 per cent to £23.4m over the same period. The company said it was looking at 11 new locations for stores and would have two new garden centres by next spring.

A well-run, traditional business it shows that Aim listing is for more than just high tech stocks.

Risks: Unless the British love affair with floral borders, decking and water features dries up, the only danger for Dobbies would seem to be a challenge from one of the big DIY store operators.

* MATRIX COMMUNICATION GROUP

Floated: January 2001

Market cap: £21.8m

What it does: "The UK's communications integrator of choice for leading edge technologies." It provides support for large computer networks up to and including the internet.

Why it's a good buy: A classic "Penny Share", it has suffered along with all telecoms and internet shares since they went out of fashion in 2000. Its name until March, "Offshore Telecom", and confusion over a Berlin listing have not helped. Recently it has had a series of high-profile contract wins, including one from Vodafone. Interim results last month showed profits and turnover rising.

Risks: Recovery in the sector remains fragile. Matrix could be vulnerable.

* TISSUE SCIENCE LABORATORIES

Floated: December 2001

Market cap: £37.9m

What it does: Research, development and marketing of tissue implant products.

Why it's a good buy: Tissue Science's main products are well established and approved by the appropriate regulatory bodies. Its main product, Permacol, uses collagen from pigs, which is very similar to human tissue, for reconstruction after surgery. New applications are constantly being researched. It is a growing market covering hernia repair and stress incontinence reduction. The company has recently signed a worldwide agreement with Zimmer for orthopaedic use of the product.

Risks: Unless another company comes along with a cheaper artificial version of the product, Tissue Sciences seems to have its market stitched up.

* JOURDAN

Floated: October 2002

Market cap: £13.5 million

What it does: Mini textiles conglomerate

Why it's a good buy: Small conglomerate; having a finger in several pies reduces risk.

Jourdan owns Corby trouser presses; Nelson's satin labels; Suncrest fire surrounds and Westfield Medical, which makes sterile packaging. Corby and Nelson are market leaders, Suncrest has struggled and Westfield has grown. Jourdan shares look attractive thanks to chairman David Abell and managing director Bob Morris cutting costs. Last year Jourdan made an adjusted pre-tax profit of £800,000 on sales of £24.6m. This year, a profit of £1.1m on £25.6m sales is expected.

Risks: It is difficult to keep your eye on the ball with such disparate businesses.

* MONEYBOX

Floated: March 2004

Market cap: £94m

What it does: Operates convenience cash machines (ATMs) in the UK, Netherlands and Germany.

Why it's a good buy: Cashpoint, the main competitor for Moneybox, was the subject of a £75m reverse takeover bid by HBOS at the end of May. Although this leaves Moneybox in second place in the convenience ATM market, it turned in a healthy £2m profit for the 11 months to last December and there is room for growth. Recent research by Sainsbury's Bank suggests there will be 43 million withdrawals from independently-operated ATMs this year.

Risks: Informing consumers of £1.50 charges for withdrawals could lead to a backlash. Greater danger comes from the potential entry of foreign competitors.

* TOP TEN

Floated: March 2002

Market cap: £29.5m

What it does: Bingo Operator

Why it's a good buy: The government's proposals on gambling gave a boost to bingo. New laws, which are planned to come into effect in 2005, should reduce the threat to "traditional" bingo clubs from aggressive casino operators. Top Ten is the third-largest player, a long way behind Gala and Mecca, but is growing fast by acquisition. Top Ten returned impressive figures in the year to March when it more than doubled profits to £1.27m and almost doubled earnings per share to 0.29p.

Risks: Bingo is hardly at the cutting edge of leisure pursuits and there is no limit to the competition for people's time.

These stocks have been selected on the basis that they have the potential to rise substantially in value over the next 12 months or so.Some are more speculative than others.

There are companies recovering after a disastrous period, but there is no guarantee that their recovery will continue. Others have a more sound track record, but that does not mean they will not run into unforeseen difficulties.

If buying shares in any of these companies appeals to you, do not make a move until you have done a great deal more research.