Even with generally bullish sentiment across the markets, the fact that the Alternative Investment Market (AIM) has risen by 33% over the past year represents reflects a hugely impressive performance by the UK’s small caps.

 

Those that were in the market twelve months ago are probably identifiable by their rather self-satisfied grin, but what about those considering taking the plunge into the junior market in ISA season? Small company shares are now a third more expensive than in the run up to the EU referendum, and the question is, will they run out of steam, or is there further to go?

Rules-based stockmarket investing platform Stockopedia believes that there are techniques  that can be employed to give you a chance of picking stocks that are worthy of the premium rather than just enjoying the ride.

Stockopedia reasons that a pricey share may not be ‘expensive’ as long as it delivers premium quality and momentum.

Companies including some of the market’s best quality stocks such as JD Sports and Diageo, with strong share price momentum and a strong historical performance, can almost always seem expensive; this may put some investors off, despite the fact that they have delivered excellent returns over time.

However, whilst value investors may find little to excite them, momentum or trend investors, can achieve great success by ignoring the price and surfing the bow waves of these high-flyers.

There are some key features to look for in search of high quality companies with momentum.

Firstly, a high quality company is generally stable, high margin, growing its sales and earnings and usually highly profitable; strong momentum will manifest itself in stocks trading at, or above, their 52-week high and performing strongly within the market – a good sign is when a company exceeds brokers’ expectation causing them to upgrade the stock or change their recommendation.

Stockopedia simplifies this by scoring and ranking every company in the market with a quality rank and a momentum rank based upon the above metrics; according to its methodology, companies considered ‘high-flyers’ could have little to interest the value investor.

‘the trend is your friend, until the end, when it bends’

Over four years Stockopedia has tracked companies valued at between £50m and £350m in search of high-quality and momentum small-caps and in that time, companies in the top 20% of the market as ranked by their combined quality and momentum scores have delivered a theoretical return of 110%. Companies with the lowest scores fared considerably less well.

There are some impressive stats to back up Stockopedia’s conclusions; its five highest ranked companies according to its quality and momentum characteristics have delivered an average of 63.4% year on year increase in their share price across diverse sectors such as telecoms, technology and healthcare.

YouGov,  the data and analytics company scores 98 on Stockopedia’s quality and momentum rank, and that is almost matched by the 95.6% hike in its share price; growth company AB Dynamics achieved a 94 rating and a 94.9% increase in its share price.

Such companies are not the high flying biggest fish in the smaller pond, they are typically growth companies with momentum that could otherwise be considered expensive; however, identified according to their risk and momentum characteristics, they could be the ones to watch if there are concerns about AIM’s ability to maintain its recent stellar performance – after all, companies such as ASOS and Boohoo were once small AIM stocks.

The old adage is that ‘the trend is your friend, until the end, when it bends’; there is always the risk that a stock, a sector or a market will run out of puff, particularly with small cap; however, if you are considering AIM, whether a stock is expensive or indeed looking for a coat tail to grab, Stockopedia’s method is one to consider.

 





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