Donald Trump should phone Xavier Rolet for advice. While much of the London Stock Exchange chief executive’s time of late will have been focused on a failed merger with Deutsche Borse, he has nevertheless managed to MAGA – Make AIM Great Again. 
Once derided as a home suited for only start-ups and corporate misfits, London’s junior market has undergone a renaissance over the last two years.
Out are questionable Chinese companies like Naibu, the sportswear brand whose board infamously lost all contact with their management team, and ‘in’ are some of the UK’s fastest growing companies.
While admittedly lacking the same cachet as Nasdaq’s ‘FANG’ quartet, AIM’s ‘PFAB Four’ of Purplebricks, Fevertree Drinks, ASOS and Boohoo.com have rewarded investors well. And yes, that only really works if you adopt a German accent.
By tightening its standards of corporate governance, aided by a supportive regulatory backdrop (AIM-listed stocks offer investors various tax relief opportunities), and buoyed by several stand-out performers, the FTSE AIM 100 Index has reached new all-time highs.
In 2017 alone, the index has risen by over 25 per cent – comfortably outstripping the performance of each of the ‘main market’ indices.
Question marks have been raised, however, about whether valuations have become too stretched. Is the AIM market a bubble waiting to burst?
A cursory glance at the ten stocks with the greatest weighting in the FTSE AIM 100 could give some cause for concern. The cheapest of those, using price-to-earnings (P/E) as a simple proxy, is pharmaceutical services company Clinigen, which trades on a prospective P/E of 21x.
An average P/E, excluding two loss-making companies, of 44x for these ten companies far exceeds the FTSE All-Share average of 15x. Most of these companies, however, are classic growth companies and it would be surprising if they did not trade at eye-wateringly lofty valuations.
Fevertree Drinks, the maker of premium mixer drinks, has a market capitalisation of £2.7bn despite only being forecast to generate around £150m in sales in the current year. Holders of the stock can point to the rapid rates of growth the business is achieving to justify the share price.
During the first half of 2017, Fevertree doubled sales in the UK while it has barely scratched the surface of its potential elsewhere. Since its IPO in 2014, Fevertree’s share price has increased more than ten-fold and its investor base has transformed to include many of the UK’s largest institutional shareholders. In a sense, it is now largely irrelevant whether Fevertree has either a premium market or an AIM-listing – its fortune largely resides within its own hands. Continue to grow at such a rapid pace and the present valuation will one day appear a bargain; or fail to meet expectations and suffer a savage de-rating.
The success of companies like Fevertree, though, may have helped inflate valuations in some AIM-listed stocks whose prospects are somewhat more prosaic.
Attracted by the tax advantages on offer, retail money has flowed into funds designed solely to invest in AIM-listed companies.
As these funds grow, they need to find suitable homes for this capital. Diversification requirements means they can’t just put it all in the ‘PFAB 4’ (this really isn’t catching on) but a lack of liquidity prevents them considering the long-tail of stocks on AIM where trading volumes are thin even on a good day.
FTSE AIM 100 vs FTSE All Share over 3yrs
Source: FE Analytics
As these funds grow, they need to find suitable homes for this capital. Diversification requirements means they can’t just put it all in the ‘PFAB 4’ (this really isn’t catching on) but a lack of liquidity prevents them considering the long-tail of stocks on AIM where trading volumes are thin even on a good day.
Nichols, the makers of Vimto, now trades on a P/E multiple of 25x versus main-market peers like AG Barr and Britvic on 20x and 13x respectively and above its long-term average. Manufacturer of floor coverings, James Halstead, has delivered low to mid-single digit operating profit growth in recent years but trades on a PE of 24x. While there is no reason to doubt that these companies are well-run, valuations appear elevated.
Correctly identifying a bubble is difficult, timing when it eventually pops even more so. The failure of one or more of the largest AIM stocks, especially if caused by a failing of corporate governance, could dent investor confidence and lead to capital flight.
The tax shields on offer to investors, though, often more than compensates for poor fund performance. A shift in the regulatory environment may prove the catalyst. While the rationale for having an exchange with a lower regulatory burden for smaller companies and encouraging investment in such businesses remains valid, it is questionable why a long-term investor in Nichols should receive benefits that a similar investor in AG Barr does not.
Or maybe it will be an unforeseen macro event that will spook investors – a tweet from the account of @realDonaldTrump perhaps? In that case, an AIM bubble will be the least of our concerns. #sad.
Neil Veitch is manager of the SVM UK Opportunities fund. All views are his own and should not be taken as investment advice.