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This AIM stock is nearly big enough for the FTSE 100 – and can keep growing!

Burford Capital (LSE: BUR) has grown 10-fold in the last 3 years and now has a market cap of over 4 billion. Most investors won’t be familiar with Burford because it operates in a new sector and has only been listed on the Alternative Investment Market (AIM). It provides capital to the legal sector, covering the costs of cases for legal companies and corporations, and is rewarded if the case is settled or there is a payout. Burford takes on the risk that legal firms and corporations are unwilling or unable to take, and has become an expert in investing in the asset value of legal claims.

Reasonably valued for a quality company

Return on capital employed (ROCE) is a good measure of how well a business is utilising its funds, and one that is recommended by Warren Buffett. Burford has a ROCE of 17.5%, which is extremely efficient. It also has an 82.1% operating margin as its costs are very low. As long as Burford has a high ROCE, the small dividend is not a drawback as the company should be generating superior profits on that capital, which should reflect in an increasing share price.

The company currently has a price-to-earnings ratio (P/E) of 19, although in the current bull market I think a P/E of 30 based on its high quality and current level of growth would be fair. Compared to other investment companies such as the high flyer Hargreaves Lansdown, which has a similar profile and a stretched P/E of 37.7, Burford looks very reasonably priced.

High risk, high reward

Most people will know how risky litigation is and how long cases can last, which could lead to very unpredictable earnings for Burford. Fortunately the size of the payouts are much higher than legal costs, which has led to Burford having a good record of beating expectations. The company is run by former lawyers who know legal cases very well and are skilled at assessing the level of the risk involved, and as a result only invest in a small amount of cases that they are offered.

Some investors may not be comfortable with the amount of value that this company has locked into legal cases but this provides considerable benefits. The payout from claims is not correlated with market conditions and results should not suffer in the event of an economic downturn. Burford also has a significant advantage as market leader, as its reputation and large capital base make it very difficult for new companies to compete.

Buy and hold

This is a company that I would buy and hold as the risks in this sector and the speed that it is growing at will cause some price volatility; however, it is reasonable to assume that these will level out over the long term. The CEO has stated that it is comfortable listed on the AIM but if Burford continues to grow then it may consider joining the main market to enhance its reputation. This should increase the value of the share price as tracker funds would purchase shares of Burford when it joined the index.

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Robert Faulkner owns shares in Burford Capital. The Motley Fool UK has recommended Hargreaves Lansdown. 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 us better investors.