The AIM junior stock market has delivered some rich pickings for investors over the years but also some risky bets that have blown up.
Investing in smaller companies can bring great rewards and plenty of excitement, but you must also do your research well and look for solid firms.
As a starting point for small cap investors, we asked Interactive Investor’s AIM expert Andrew Hore for his pick of five AIM-listed stocks to consider for your Isa.
Time is running out for investors to take full advantage of their first opportunity to invest up to £20,000 in an Isa
Andrew Hore writes: I am looking at potential AIM investments that have good growth prospects from their existing operations and, in some cases, potential to enhance that growth via acquisitions.
Most of these companies are still at a relatively early stage and they are not all profitable, and most do not pay dividends (dividend payers are the subject of the next article).
These companies should be thought about as long-term investments because the timing of the growth in the businesses is difficult to predict.
The surgical instruments supplier has just returned to profit and the earnings enhancing acquisition of UK distribution business Elemental will further boost profitability.
Surgical Innovations is in a growing sector for minimally invasive surgical instruments and having its own distribution activity will help it to launch new products through greater contact with its customer base. There is also a lot of scope for international growth.
Elemental has signed a three-year distribution agreement with Bariatric Solutions GmbH, which supplies medical devices for obesity surgery. This will widen the range of products the sales force can offer, although it is unlikely to be a major contributor in the short-term.
In the six months to June 2017, revenues were 14 per cent higher at £3.47million, thanks to growth in the UK and from manufacturing for other brands.
There was a swing from an interim loss to a pre-tax profit of £300,000. This was achieved despite a large increase in overheads prior to further expected growth.
House broker WH Ireland forecasts a 2017 pre-tax profit of £1.16million, up from £280,000. These figures will be published on 13 March.
A full year contribution from Elemental is expected to enable profit to rise to £1.86million in 2018, with help from new product launches.
The shares are trading on 15 times prospective 2018 earnings with potential for additional earnings growth from adding products to the range.
Online gaming marketing and promotions company Veltyco reversed into an AIM shell less than two years ago ,and it has rapidly grown its revenues and profit both organically and via acquisitions.
The underlying pre-tax profit has soared from €1.74million (£1.55million) to €7.77million (£6.92million) in 2017 thanks to a low overhead base with most of the costs spent on marketing, the level of which drives the rate of growth.
Veltyco has revenue share agreements with platform operators. The acquisition of Bet90 means that Veltyco operates its own online brand.
This means that revenues will be split between marketing for other platforms and revenues from brands that Veltyco owns.
Further acquisitions are likely and Veltyco has an experienced team that has shown that it knows how to identify a good acquisition.
There are new growth areas. For example, eSports is an area that is growing rapidly and there is potential for betting. Veltyco has signed an agreement with online portal eSports.com to enable online betting on eSports events
This is a cash generating business and that cash can be used for expansion. No dividends have been paid, as yet. Net cash could be nearly €9million (£8.02million) by the end of 2018 – if no acquisitions were made.
The forecast 2018 pre-tax profit of more than €10million (£8.91million) puts the shares on a prospective multiple of less than nine.
Veltyco has a record of positive trading statements leading to regular forecast upgrades so the current forecast may prove conservative. One concern is a lack of liquidity, but Veltyco is aware that it needs to do something about that.
Ilika mainly focusses on solid state battery technology, but there are other potential markets for energy materials and aerospace alloys technology according to Hore
Advanced materials developer Ilika has been quoted for nearly eight years and it has made technological progress but very little in the way of real commercial progress.
Revenues still mainly come from grants and research funding provided by outside parties. This could start to change in the because Ilika has a number of potential deals in the pipeline.
The main focus is solid state battery technology, but there are other potential markets for energy materials and aerospace alloys technology.
The strategy is to secure an upfront licence fee from a major company for a specific use for a technology and then generate royalties based on a percentage of volumes shipped. The technology would be licenced for multiple applications.
Solid state batteries that use Ilika’s Stereax technology have a 40 per cent increase in energy density. They can also operate at higher temperatures and last longer.
There are projects using Stereax in miniature medical implants, autonomous sensors and condition monitoring of turbine blades. There are also a handful of R&D programmes and licensing proposals but there are more than 40 other non-disclosure agreements with potential customers.
The downside is that the timing of licence agreements has been delayed and it is difficult to assess when they will happen.
Most importantly, for a business with uncertain cash flows, Ilika has plenty of cash to tide it over for a couple of years at least.
Cash is expected to be £2.3million at the end of April 2019. This means that it does not matter if no significant commercial deals are signed this year. There is still plenty of time. Licence agreements will provide a catalyst for a share price rise.
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Insurance and financial services businesses investor BP Marsh has a strong track record. Total shareholder return was 13.9 per cent last year and 13.7 per cent the year before.
Management do not chase fashions, such as cryptocurrency, but focus on solid financial businesses with growth potential.
The experienced management team has steered the company through the ups and downs of the market since it was established in 1990 with an initial £3million investment.
BP Marsh raised £10.1million when it floated on AIM in February 2006. This capital and subsequent gains have been recycled over the years in order to achieve growth in net asset value (NAV).
The focus is early stage investments in financial and insurance-related businesses. The scope is international. BP Marsh takes a significant minority position in companies (typically between 20 per cent and 40 per cent) with experienced management teams.
As the investee company develops, BP Marsh will provide introductions to contacts, strategic advice and support as well as follow-on investment if required.
At the end of July 2017, the NAV was 304p a share. The discount to that NAV has narrowed to 9 per cent in the past few weeks. That is partly because a change in the substantial shareholding exemption taxation rule will remove the deferred tax provision in the balance sheet and should boost NAV by £4.9million.
Unlike the other companies in this article BP Marsh pays a dividend and it has confirmed it will be increased from 3.76p a share to 4.76p a share this year.
Frontier IP helps companies and research institutions to commercialise intellectual property, but instead of investing a cash sum, Frontier IP gains a shareholding by providing finance and administration advice and services, as well as introducing suitable commercial partners.
This enables the investee companies to focus on developing commercial products and getting them onto the market. The portfolio covers sectors that include life sciences, robotics, green materials and electronics.
Investee company MolEndoTech has secured a subsidiary of fully listed Halma as its partner for a test for faecal matter in marine bathing water.
Frontier IP had a 19.6 per cent stake in MolEndoTech, a Plymouth University spin-out, with a book value of £10,000 but the proposed £500,000 investment in the company would dilute the stake to 14 per cent. The cash will be used to invest in sales and new water testing products.
This is a good example of how the strategy should work. It will not work every time and there is still some way to go for MolEndoTech, but in one year it has a product on the market and the cash to grow the business, while Frontier IP has a valuable investment.
The Frontier IP share price appears high compared to the book value of investments but many of these are at low valuations, just like MolEndoTech.
This is undoubtedly a long-term investment because some of the investee companies will fail and others will take time to come to fruition.