UK shares aren’t exactly known for trading at ambitious multiples. But some of the lowest valuations can be found outside the FTSE 100 and the FTSE 250.
The Alternative Investment Market (AIM) was set up to support businesses in their early growth stages. A lot of the time though, investors systematically overlook these opportunities.
Alternative investments
The requirements for listing on AIM are lower than the main UK markets. So it provides opportunities for companies – and investors – that they wouldn’t otherwise have access to.
Often though, AIM-listed companies get overlooked by institutions. One – perfectly good – reason for this is that they often aren’t big enough to be significant investments for them. Another is that AIM stocks can be riskier and more volatile.
Industrial lighting company FW Thorpe (LSE:TFW) is an example of a smaller company. It has a market value of £352m, but 50% of its shares privately held, so there’s only £175m available to buy.
That’s not big enough to interest big investment firms. But it’s not an issue for ordinary investors and the lack of attention helps keep prices down.
Quality business
Many AIM-listed companies may be small, but this doesn’t necessarily make them inferior investments. In the case of FW Thorpe, the firm has some clear strengths.
One is that it’s vertically integrated, designing and manufacturing its lighting solutions in-house. This gives it an advantage in terms of reliability, as well helping with cost control.
Its decentralised structure is also a strength. Having individual businesses that can make their own decisions allows it to be more responsive to specific customer needs.
Other companies can emulate this. But it puts a lot more emphasis on finding quality managers at the subsidiary level, a risk for a larger organisation.
Low multiples
FW Thorpe does give away a lot to some of its competitors in terms of scale. And that’s a risk – there are advantages that come with being a bigger operation that the firm doesn’t have.
Despite this, the company has got itself into a strong position. It has a debt-free balance sheet, consistently achieves strong returns on equity, and has grown its dividend over time.
Despite all this, the stock currently trades at a price-to-earnings (P/E) multiple of 14. So the obvious question investors need to ask themselves is: why is this?
The obvious reason is that the stock doesn’t attract the same volume (or type) of buyers as its larger counterparts. But for investors looking to buy and hold for the long term, that isn’t necessarily a problem.
Warren Buffett
The stock market is a crowded place right now and prices of some large stocks are through the roof. Warren Buffett said at a recent Berkshire Hathaway meeting that if he were starting again, he’d look at smaller companies.
I think this makes a lot of sense. In a crowded stock market well-covered by analysts, it can be hard to find opportunities others are overlooking.
Valuations in the UK, however, tend to be a bit more modest than across the Atlantic. And AIM seems like it’s often overlooked by a lot of analysts and investors.
FW Thorpe is one I’ve got an eye on for my portfolio. At today’s prices, I’m looking at it as a potential opportunity, but there are several others also on my radar.
