The UK stock market is still some way below the level reached before May's sharp correction, and now...
The UK stock market is still some way below the level reached before May's sharp correction, and nowhere is this more evident than among smaller companies.
Although the FTSE 100, FTSE mid 250 and FTSE 350 indices have all gained roughly 5% since hitting lows at the end of May, the FTSE Small Cap (ex IC) index's recovery has been less vigorous, as it has rallied by a mere 2% since then.
Meanwhile, the FTSE Aim market remains mired in gloom and has still yet to move onto positive ground. Since the May low it has lost a further 5%. But Aim's ongoing descent can be rationalised by two factors.
First, because companies that list their shares on Aim are subject to less stringent regulation than if they had chosen a main market listing, they are perceived as relatively higher risk. So when uncertainty is the dominant market force, Aim stocks get punished severely.
Second, it is seen as a small-cap orientated index and as such can suffer disproportionately when liquidity evaporates.
However, the market downfall also represents an opportunity to buy stocks at highly attractive levels.
Aim is in effect a stock picker's market. It boasts 1,560 members (as of end July), eclipsing the wider FTSE All-Share's constituents by a factor of more than two. Given that a substantial proportion of Aim companies have very strong businesses, this makes their risk/reward profile very appealing.
Moreover, Aim is an under-researched sector of the market, making the present opportunity even more compelling for a well-informed investor. Being off the 'analyst coverage' radar enables those investors who do their own stock evaluation to spot potential high flyers before they are discovered by the wider market, and thereby glean additional value.
A prime example of an Aim-listed stock with seriously unrecognised potential is Cape, which provides fire protection, insulation and building products for the construction industry.
However, since swinging into operating profits in 2004, Cape successfully extended its core market to encompass the energy industry, via a dual strategy of acquisitions and organic growth. Its core operations have since seen steady growth thanks to the combination of a favourable market backdrop and the firm's corporate strategy, including a stringent cost-cutting programme. As a result, the group's financial position is now extremely robust.
Perhaps more importantly, Cape's asbestos-related woes are now well and truly in the past. In June the company won legal approval to set up an Asbestos Scheme of Arrangement, enabling it to create a £40m fund to finance the majority of future claims. This is significant on two counts. Not only does it de-risk the business it also allows management to devote more time and resource to its still-expanding core services operation.
Cape's shares have been drifting upward of late, suggesting the market is beginning to wake up to the company's exciting growth prospects, but with a current PE ratio of circa 12 times, the company is still grossly undervalued.
When considering that such stocks with genuinely attractive upside potential are not a rarity on Aim at the moment, this offers seasoned investors a window of opportunity to sow the seeds that will help generate future outperformance.key points
May's correction hit UK smaller companies sector hard
Small companies offer buying opportunity
AIM is a stock pickers market
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress