Edie Lush goes hunting for recession-beaters and game-changers in the smaller companies sector
Uncertainty reigns among UK investors. Will this week's Budget cuts wither the green shoots of growth? Whatever happened to safety in blue chips when BP's dividends can vanish into an oil slick? Where's a stock-picker to turn?
If the words 'small cap' don't send you rigid with fright, then there are good reasons to look towards AIM, London's market for listed smaller companies. You'll find businesses there that are an unusually good bet in tough times. And you'll find some that are sufficiently global, despite their modest size, not to flinch at a prolonged UK downturn.
Long time AIM watcher Tom Bulford, author of the Red Hot Penny Shares newsletter, identifies the key time to invest in an AIM-listed company. There are the early 'fantasy' years of a company - when it has little more to offer than an idea for a product or service. 'Almost without exception it takes these companies longer to bring their plans to fruition than they expect. This can mean having to raise extra finance along the way.
Investors in such companies should treat all forecasts with a large pinch of salt.'
Then there's an inflection point, after they have proved the demand for the key product.
Bulford says the trick is to invest at this point, towards the end of the fantasy years, 'when the company is on the verge of actually producing some revenue'.
He points out that while AIM-listed companies are almost universally stigmatised as high-risk, many have strong business models and solid finances. 'They're small, but many are well established, profitable, with steady income - like patent translator RWS or flooring manufacturer James Halstead.
They're far less risky than many big companies - just look at BP or RBS, ' he says.
So where to look on AIM? Some companies shine when the rest of the world seems dull: canny pawnbrokers, for example, have come through the recession with cash in their pockets, and should even thrive in a double dip. Charles Breese and Mark Wolff of LCF Research point to Albemarle & Bond, the UK's largest pawnbroker. It raked in a 42 per cent rise in profits last year and is using the proceeds to expand through 'pop-up' (shortlease) shops that take in and resell jewellery.
Ethically uncomfortable? 'A&B helps people make ends meet without impairing their future wealth, ' says Breese. 'Unlike loan sharks, they integrate with the local community and give a fair price to their clients.'
There is an OFT investigation into internet gold buyers, some of which are thought to have been offering unfair prices - as Dominic Midgley wrote here recently - but A&B is not under scrutiny. Gold bugs beware, however. The price of A&B shares is linked to the gold price, because the firm breaks down jewellery and resells the gold content. Gold hit an all-time high of $1,250 an ounce earlier this year but should anything cause its market to shudder, the pawnbrokers' stock price could shake with it.
Companies with global customers are insulated from a UK downturn and benefit if the pound stays low, keeping export prices low.
Independent fund manager Jeremy Le Sueur recommends 4Imprint, which makes corporate promotional materials such as laptop bags and eco-friendly shopping bags, and has previously done well in the early stages of a US economic recovery.
Le Sueur also likes Mothercare, which despite relative misery on the high street at home is doing well overseas: 40 per cent of the baby store's profits are made from its overseas franchises, primarily in Europe, the Middle East and the Far East.
Mark Wolff of LCF Research points out that companies which help other companies make better spending decisions, or help them sell their own products better, are worth a look.
Online market research company BrainJuicer may have a weird name, but counts 11 of the world's top 20 buyers of advertising as its clients. The company was founded in 1999 by John Kearon, who calls himself its 'Chief Juicer': he felt traditional market research was slow, expensive, inaccurate and shallow, so he developed research tools, inspired by avant-garde sociological and psychological research, that could be delivered through the internet. BrainJuicer helps companies find out what customers think about a new product while it's still being developed. Most importantly, BrainJuicer does research faster and cheaper. One client comments on the company's website: 'BrainJuicer took just 10 days to do what would normally have taken six weeks, for a fraction of the price.' Clients include Unilever, Philips, Publicis, Nestle and Nike, and the company's ambition is to become a top ten market research agency.
Jeremy Le Sueur picks another technology company that saves its customers money.
SQS is a European market leader in testing software for companies, a business 'growing strongly as companies realise that implementing lots of different software systems proves to be extremely costly when it doesn't work first time round'. One of the areas SQS works in is the automotive industry - helping to avoid car recalls by carefully testing the different software systems in new models. Want to avoid airbags that fail to inflate, wrong injection sequences, or problems with the anti-lock braking system? SQS helps find any faults in the software and cut costs in the development process at the same time. Daimler and Volkswagen are among its clients.
Other AIM companies can not only save you money but potentially save your life.
They're in medical technology, an area of which UK investors have historically been wary because they find it hard to understand and because companies in it take so long to bring products to market - through years of clinical trials and repeated rounds of fundraising. But for those who take the time to understand the meditech market, lucrative opportunities exist, say Wolff and Breese of LCF Research. They're convinced that favourable demographics - ageing populations with rising expectations of quality of life - will spur demand for further advances in medical technologies. In general, they recommend avoiding 'pure therapeutic plays' (chiefly new drugs) which can face very long lead times, and instead concentrating on the diagnostic sector, where regulatory barriers are lower and products reach market faster.
Epistem is an AIM company that has developed a diagnostic test using stem cells in the base of a plucked hair to find out whether a particular cancer medicine is likely to work on a given patient. This ingenious approach has the potential to save patients and healthcare providers money by avoiding drugs that won't work in an individual's case. Big pharma groups such as GSK, Merck and Pfizer are using Epistem's products and services to test new drug candidates in clinical trials.
Epistem is also in a major drug discovery collaboration with Novartis, which may eventually lead to new cancer therapies. In the meantime, the company is already profitable and cash generative - unlike most biotech companies that are developing leading-edge drug therapeutics. Breese says Epistem's approach is 'the future of medicine', offering increasingly personalised and efficient diagnosis and treatment.
No investor should, of course, follow any of these illustrative AIM tips without doing their research first. But in these times of budget cuts and blue chip blues, the smaller end of the listed-company spectrum is well worth exploring. There are all kinds of interesting businesses down there, and in their different ways, many of them are in tune with these difficult times.
Edie Lush is an associate editor of Spectator Business.
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