AIM highs and lows of 2018 - and a checklist for avoiding disasters

Sixteen companies were forced off the Alternative Investment Market last year because of financial stress or insolvency. That was up from nine companies that suffered the same fate in 2017. When you add them to those that hit problems but somehow managed to cling on (albeit with broken reputations and battered share prices), it’s a reminder of just how perilous the AIM market can be. So how can you try to avoid these kinds of problems?

AIM is popular with investors looking for the kind of explosive growth that happens when smaller, less well known companies come good. A lack of decent research means there can be hidden gems in AIM’s wild expanse of just over 920 mostly small-cap stocks. It’s a market that captures the essence of Jim Slater’s famous observation, that “elephants don’t gallop”. His message being that big companies don’t grow anywhere near as fast as small-caps, and neither do their share prices.

To be fair, there have been some great examples of that kind of growth in recent years. With investors risk-on and funds flowing into speculative plays, some names have seen big re-ratings. They’ve included companies like Burford Capital, Fevertree Drinks, Abcam, Boohoo and Clinigen. From a market cap-cap perspective, Burford’s £3.7bn valuation wouldn’t be out of place in the FTSE 100. Three years ago, it was worth just £400 million.

These are now some of the biggest companies quoted on AIM. Their performances through 2016 and 2017 contributed to the index outpacing all the other main UK benchmarks. But when markets slid through 2018, it was AIM that suffered most – falling 18.2 percent through the year.

Sudden shocks

While AIM has had successes, the trade-off for investing in such a fast-growth, light-touch place is that things go wrong. Unlike the main market, where corporate distress is often (although not always) flagged by analysts, AIM calamities can take everyone by surprise. Just ask investors in Patisserie Holdings.

In 2018, the group behind the Patisserie Valerie chain of cafes – which is majority owned by the chairman and entrepreneur Luke Johnson – was plunged into chaos by an accounting crisis. The full details of what could be a serious fraud still aren’t known. But the shares have been suspended for more than three months while investigations take place. For investors in what was once highly regarded as a super profitable roll-out, it’s a complete mess. But Patisserie Valerie wasn’t the only disappointment last year…

Accounting reviews

In late 2017 and early 2018 Utilitywise, the energy consultancy, found its shares suspended for a short time because it wasn’t able to publish its full year results. Having previously flagged that it was introducing new accounting policies, the company got swept up in a painful review of its revenue recognition policies. It was more bad news for a stock that had been suffering negative momentum for nearly five years.

Later in the year another energy supplier, this time Yu, which had IPOd in in March 2016, announced that historic accounting errors had come to light. At first £10 million, and later another £2-3 million, was wiped off its profits, and the impact on its share price was huge. Yu’s market cap fell from over £130 million to just £30 million in a little over a day.

In some cases, detecting problems early is very difficult to do. In the case of Patisserie Holdings, where the precise issue is unclear, it’s impossible to know what the warning signs might have been. With Yu, from the outset of its IPO, it was flagging for high risk of earnings manipulation against the Beneish M-Score (as seen on Stockopedia StockReports). While it would need a closer look at the exact issues, it looks like the M-Score may have detected some of these problems quite a long way out.

Complete collapse

Major profit warnings in small-caps like Yu often lead to huge value destruction, which is something we’ve analysed in the Profit Warning Survival Guide. But at least Yu is still standing. For a number of AIM listed firms, financial distress proved to be the end in 2018…

Each disaster came with its own sorry story. Some were broken models, others badly managed and at least one looked criminal. Among some of the names were companies like Fishing Republic, Crawshaw, Rex Bionics, Flowgroup, Conviviality and MySquar.

In some cases, the likelihood of collapse was flagged by analysts like Stockopedia’s Paul Scott and Graham Neary, who were on top of problems at Conviviality, Flowgroup and Crawshaw. But while it’s possible to predict problems in some firms, it’s not quite so easy in others – Patisserie Holdings being a good example.

Investment checklist

So for investors considering AIM as a venue for finding exciting new growth stocks in 2019, there are a few warnings. While the market has been home to some excellent investments in recent years, there are always vulnerabilities in small-caps. Taking a checklist approach to avoid problems could help. Here are some considerations – but feel free to suggest some more!

Is there a high Earnings Manipulation Risk?

A risk meter like the Beneish M-Score can be useful in detecting erratic earnings trends. While it might not pinpoint the the exact problem straightaway, it will flag the need for further investigation.

Is the StockRank falling?

If a stock is seeing a decline in its overall exposure to the three factors of Quality, Value and Momentum, it could be a signal that all is not well. Here’s a simple screen that does the opposite and looks for AIM shares with high StockRanks: High ranking AIM shares screen.

Broker downgrades amp; estimate cuts

A lack of research coverage of AIM shares means that it can be hard to detect meaningful trends in EPS forecasts and recommendations for every company. But where they do exist, these figures can flag areas of concern.

Flagging 1 year Relative Price Strength

Has the market fallen out of love with the stock? Is it underperforming the main AIM index? If so, that could be a signal that the market knows there’s bad news on the horizon.

Is the debt pile growing?

Cash burn is a key features of small-cap companies and access to funding can be critical. If investors aren’t willing to step in, debt finance might be the only option for some firms – but is that debt pile manageable?

Photo by Matt Bowden on Unsplash

Stockopedia