The AIM market has a split personality. On the one hand, the market contains some incredible British success stories. Take ASOS and Boohoo.Com, two wonderful growth companies that have seen their share prices rise 1,540% and 200% respectively since listing – and that’s just in one sector.
Yet AIM also destroys more than its fair share of value due to its more relaxed regulatory structure. This makes it easier for smaller companies to gain funding, but also attracts shady characters from around the world. Take Globo plc , an out-and-out fraud that exploded spectacularly back in 2015 after admitting to the “falsification of data and the misrepresentation of the company’s financial situation.” If that isn’t a shareholder’s worst nightmare, I’m not sure what is.
Many investors give this ‘Jekyll and Hyde’ market a wide berth, a stance I can empathise with. That said, investors could quickly sidestep the majority of duds by learning a few simple rules of thumb.
You don’t need to pass on opportunities like ASOS to keep your capital safe. Today I’ll outline three guidelines I believe are paramount to avoiding calamity in the AIM market.
Remain sceptical of foreign companies
Investing in foreign companies is often a great idea due to the diversity it grants us, but the lax regulatory structure of AIM makes it a prime target for overseas fraudsters. Take, for example, recent accusations levelled at the now ex-CEO Oozi Cats of Israeli company Telit Communications (LSE: TCM). Apparently, he fled the US back in the early 90s after being caught committing wire fraud. The shares have dived 36% since the news broke earlier this month.
Sometimes a foreign company has a decent reason to list on AIM, but if management isn’t forthcoming with a reason, I’d advise you to remain sceptical.
Avoid cash-consuming start-ups
If a company can’t turn a cash profit, I steer clear regardless of how incredible the business model or its supposed competitive advantages might be. Trust me, more often than not you absolutely can wait for a business to turn cash flow positive without missing out on incredible returns. If a business is truly a long-term champion, hanging on a year or two won’t destroy your savings. Cash-guzzlers will separate you from your money on a regular basis in my experience, completely outweighing the few successes you get into early. The income statement can be influenced by all sorts of accounting wizardry, but cash is harder to fake.
Avoid IPOs, especially those paying chunky dividends.
When a company first lists on AIM, its founders and management often dispose of huge chunks of the business. Investors must ask: “If the outlook is so wonderful, why are insiders selling?”
Furthermore, new floats have a limited financial history making it harder to gain a full understanding of operations.
Finally, a large dividend is often included to entice investors, but before you reach for that yield consider this: “Why is a growth company with supposedly wonderful reinvestment opportunities pumping cash back to shareholders?”
There can be good answers to all of the questions posed above, but in my experience remaining sceptical of foreign AIM-listed companies, cash-hungry blue-sky concepts and fresh IPOs is a high-percentage approach to avoiding disasters. And in the game we stock-pickers play, avoiding huge losses is half the battle.
Could this AIM company help you become a millionaire?
In a future article perhaps I’ll outline what it takes to find AIM winners, but for now I’m out of wordcount. To conclude, I’d like to introduce you to an AIM stock that passes my guidelines with flying colours. Discovered by one of my colleagues, this little-known small-cap trades on a bargainous P/E of 7 and offers a 3% yield to boot.
This isn’t some stagnant ex-growth share either, but a company that grew operating profit just shy of 20% last year. To discover this potential diamond in the rough, click here.
Zach Coffell owns shares of Boohoo.Com. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo.com. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes