By Matt Cable.
The UK stockmarket as a whole has performed very well over the last twelve months, despite the obvious disruption from the Brexit vote last June. A glance at the various indices shows that investors have paid particular attention to smaller companies – indeed it seems that the mantra has been ‘the smaller the better’.
While the main list indices have done well, there is no doubt that the star of the show has been AIM. In simple terms performance can be seen as a combination of earnings growth and ‘rating’, by which we mean the price/earnings (P/E) multiple applied by investors. On this basis, AIM has had a good run with forecast earnings for the next twelve months around 17% higher than a year ago. On top of this, there has also been a rating increase of about 12%.
The result of this ‘rerating’ is that AIM now trades on its highest P/E multiple for at least a decade, at 17.9x (a figure which excludes loss-making companies). This compares to 14.2x for the FTSE All-Share and 12.7x for the more comparable FTSE Smallcap index. The size of this ‘AIM premium’ is unusual and should give investors pause for thought.
To try to better understand what is going on, I decided to take a look at some of the stocks that have been driving AIM’s stellar performance. Excluding resource stocks (which often move more in line with underlying commodity prices), and companies with less than £100m of market value, AIM’s top ten performers over the last twelve months were:
It seems to me that there are four broad themes at work here:
- Recovery in either profits (Taptica and RhythmOne) or rating (IQE, which has moved from c.7x to 18x P/E)
- Significant earnings growth (Burford has also modestly re-rated)
- Earnings growth with further expansion of already high multiples3 (Gear4music – 19 to 44x, boohoo.com – 32 to 69x, Fevertree Drinks 40x to 61x)
- Currently loss-making businesses with the potential to significantly disrupt markets (Blue Prism and WANdisco)
The last two groups are interesting as they seem to indicate a willingness to put aside traditional valuation disciplines. This suggests one of two things to me: either investors are right to pay up as they are visionaries buying into super-normal long-term growth; or they are simply jumping on the momentum bandwagon to further inflate an already-stretched bubble. Stocks that are ‘priced for perfection’ like this can obviously go higher still, but are ever-more vulnerable to the slightest slip in delivery which can send them crashing back to earth.
Only time will tell which way it will go for AIM’s current crop of superstars.
3 P/E multiples of next twelve months earnings now versus end of April 2016.