Don't underestimate the risks involved in investing in AIM stocks.
So far 2009 appears to have been a good year for AIM, the market for smaller companies run by the London Stock Exchange (LSE). The main AIM index has risen by roughly a third this year.
However, if you look a little closer at some of the statistics, the picture appears to be more mixed, giving a clearer indication of the risks you run when investing in this market in particular.
Delistings
Many companies on AIM have been badly hit by the credit crunch as research from Trowers & Hamlins, a City law firm, and UHY Hacker Younger, an accountancy group, has revealed. They reckon the number of AIM companies that have delisted because of financial stress or insolvency jumped from 12 in the first quarter of this year to 34 in the second.
In the first half of this year, the LSE's own figures reveal that there have been 150 delistings, only 5 of which were because the company stepped up to the main market.
These statistics reinforce the fact that you really do need to do your own research when investing in an AIM share. From personal experience, I'd say you stand a pretty good chance of losing most of your money if one of your investments delists, as you won't be able to sell a tiny stake in an illiquid company to anyone -- or you'll be offered a pittance to part with your shares.
The risks
Many AIM companies are risky plays for the following reasons:
- they're often smaller companies without proven track records;
- they're often based overseas, so it's harder to get good information on how they're doing;
- they rely on just one person, project or product;
- the spread (the difference between the price you buy and sell at) is often quite wide;
- shareholder influence can sometimes be limited because the majority of the shares may be closely held by company directors; and
- publicly available information may be less comprehensive than that provided by listed companies.
Compared to larger companies on the main market, there is certainly a greatly increased risk that you could lose some or all of the capital you invest.
Warning signs
So how can avoid the worst that AIM has to offer?
It's not easy but there are a number of classic warning signs to watch out for such as:
- being slow to update the market on price sensitive information or even late filing of accounts;
- vague announcements lacking in operational and financial detail;
- regularly raising new funds and diluting existing shareholders;
- a large number of options or warrants in issue;
- directors with a track record of disappointing investors;
- loss making start-ups whose management is being paid excessive amounts; and
- lack of corporate governance procedures.
I'm also inherently suspicious of 'buy' notes put out by a company's house broker, especially if it's the only analyst covering the share. I've let these influence some of my buying decisions in the past and usually come to regret it. They have a vested interest in making the company look attractive so treat everything you read with added caution, especially when it comes to the firm's future prospects.
Gossip on bulletin boards and AGMs can be a useful source of information too, although you need to verify what you hear and make your own mind up wherever possible.
The rewards
Of course, what makes it all worthwhile are the potential rewards. Some AIM shares have done exceedingly well and graduated to the main market. Examples that spring to mind are: Mears (LSE: MER), Lancashire Holdings (LSE: LER), Domino's Pizza (LSE: DOM) and Vectura (LSE: VEC).
I've bagged some good profits from a few of the AIM stocks that I've invested in. Indeed, I hope to revisit past successes but I minded to pass much of the pap that is touted on AIM.
More on AIM shares:
