Interactive Investor

8 expensive AIM shares still worth buying

27th November 2015 16:42

Andrew Hore from interactive investor

Some companies consistently trade on high valuation multiples, but that is because they have a record of strong results. They may slip up occasionally and they are not immune to what is happening in the wider world, but if investors want to buy shares in these businesses they have to pay for that impressive performance.

Consistent and growing profitability over a long period of time is key to these highly-rated companies. They do not work in sectors where investors have got overexcited and pushed share prices to ridiculous levels, only for the share price to subsequently slump.

An example of that was the surge in the shares of companies involved with Big Data a couple of years ago, before returning back to earth shortly after. 

High share prices with nothing to back them up can only be sustained for a number of years before they eventually suffer a heavy fall - if the performance does not back them up.

A recent example of this is mobile banking services provider Monitise. Revenues have grown significantly (although there was a dip to £89.7 million in the year to June 2015).

However, the losses made in recent years are enormous, even if write-offs of intangible assets are excluded. In the past five years, there has been an operating cash outflow of more than £144 million and, when capital expenditure is included, the figure is £259 million.

Lessons from history

A strong share price enabled Monitise to raise money to invest in the businesss, but the share price could only defy gravity for so long. The share price peaked at 80p during February 2014 - and is now 3p. There has been a 90% decline over 12 months.

Oil and gas exploration safety equipment developer Plexus has a high rating, but it has tumbled over the past two years as the oil and gas sector is out of favour and spending on exploration is being cut. That said, the Plexus historic price/earnings (PE) ratio has fallen from 93 to 31, so it is still on a high rating because of its unique technology.

The FTSE 100 index long-term average PE is around 15 and the FTSE Small Cap index tends to trade at a discount to that rating.

During the dotcom boom at the end of the 1990s, when technology and internet companies were the focus of investor hype, the FTSE 100 PE moved above 25. Nearly a decade later, when the credit crunch took hold, it had fallen to around seven.

This shows how ratings can change as economic circumstances and investment fashions change. The more soundly based companies do not tend to have such significant swings in their ratings, although they will still be affected by macro economic changes, as well as inevitable business-specific challenges.

A tough benchmark

The performance of the FTSE AIM All-Share index has been poor so it makes sense to use a more taxing benchmark, such as the FTSE Small Cap index.

During the period from the beginning of 2011 to now, the FTSE Small Cap index has increased by 41.8%. The table below includes examples of AIM companies that have not only been trading at a premium to the FTSE Small Cap index, but that have also significantly outperformed it since the start of 2011.

The constituents of the table provide some of the best examples of better-performing highly-rated companies, but there are many others. All the companies in the table have historic PE ratios of more than 20 and have generally maintained a PE above that level for most of the years.

There is a range of businesses covered, from long-established industries to technology companies. What they have in common is that they are profitable and highly cash generative. Some also have large cash piles - even though this might be frowned upon by some as inefficient use of capital.

The profits of these businesses have grown over the past five years and, although there have been some dips during the period, they are tipped to report growth in profit in the current year. The historic multiples are based on underlying earnings per share (EPS), so one-off gains and losses are excluded.

Another thing all of the companies have in common is that they pay dividends which have consistently grown over the period. A couple of the companies began paying dividends during the period under review, but most of them have been returning cash to shareholders for much longer.

   Price earnings (PE) ratio
CompanyTicker codeShare price (p)Shares +/- since 2011 (%)HistoricEnd 2014End 2013End 2012End 2011
         
Brooks MacdonaldBRK1,890962521202322
Churchill ChinaCHH6801232222211517
dotdigitalDOTD42417262520207
Gooch & HousegoGHH871842824301015
IomartIOM3002323422393141
James HalsteadJHD4501432821224117
NicholsNICL1,4302172419292417
TracsisTRCS4708503533221613

The final eight

Many of the examples in the table are predictable. For example, floorcoverings manufacturer James Halstead and soft drinks supplier Nichols regularly appear in tables of consistent dividend payers or better performing shares. They have been around for years and the share prices have risen substantially over a 25-year period.

Nichols was hampered by litigation relating to Pakistan licensee Gul Bottlers, which led to a large cash payment, which is why its historic multiple fell below 19 at the end of 2014. The rating has subsequently recovered.

Iomart

Web hosting services provider Iomart has consistently had a high rating, but the share price slumped following a profits warning last year.

This type of slip-up can lead to a sharp reaction as investors fear that it could just be the start of the disappointments. Even so, the multiple was still 22 at the end of 2014 and it has recovered to 34 times as Iomart rebuilt investor confidence because there were no more bad surprises. 

Tracsis

Transport software and services supplier Tracsis has built up an impressive track record during the past five years and this is shown by how the PE ratio has risen over time. Tracsis has developed a reputation for beating the profit forecasts of analysts.

Tracsis had a PE ratio of 13 at the end of 2011 and this multiple has increased every year since then. WH Ireland forecasts a 2015-16 profit of £6.2 million, up from £5.8 million - but history shows that the final outcome should be much better than that, particularly if the remote condition monitoring orders pick up faster than forecast.

Gooch & Housego

Gooch & Housego has also been rerated, as its position as one of the global leaders in the photonics sector becomes better appreciated.

Trakm8

Telematics services and equipment provider Trakm8 is not in the table, but it is another example of a company where the rating has increased over time.

Back at the end of 2011, the PE ratio was less than 12; now, the share price rise of more than 2,100% over the period has led to the multiple rising to more than 48, even though there has been a fivefold increase in EPS, with more to come.

dotdigital

Email marketing services outfit dotdigital moved from Plus Markets (now the ISDX Growth Market) to AIM during 2011, so the share price improvement is from the beginning of 2012.

The company had a good growth record prior to joining AIM. The low rating at the end of 2011 is probably due to the fact that dotdigital had moved from Plus/ISDX, where ratings tend to be much lower.

Sprue Aegis is a more recent example of how a company can move from ISDX and gain a substantial re-rating.

Churchill China

Tableware manufacturer Churchill China is not an obvious company to be highly rated, but it has nearly doubled its earnings per share over five years.

Brooks Macdonald

Wealth management services provider Brooks Macdonald has grown its funds under management to £7.33 billion, both organically and via acquisition. It has been able to grow steadily through various market conditions and the performance over a decade is even more impressive.

There are other companies that are profitable and have high valuations, but they have not been around long enough to assess whether they will continue to warrant these ratings.

It will be particularly interesting whether or not Fevertree Drinks can build a track record to maintain its stratospheric rating, given the relatively modest level of profitability.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

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