We recently looked at how AIM is proving a resilient growth market. But what, ultimately, makes a great AIM company? Search for advice and you’ll encounter checklists of essential advice for getting one’s house in order, for thriving in this high growth public market.
‘Having a good management team’ is generally found towards the top of such lists. Indeed, we conducted a poll of the entire finnCap team on the question ‘what makes a great company?’ and good management came out on top as the most important consideration for a company looking at the public markets. This was by some margin over other factors such as demonstrating strong growth prospects, and delivering strong returns on capital.
Assimilating a good management team is solid advice, but like many solid bits of advice offered to founders looking for guidance, it’s still an arbitrary value. What if we could attribute actual value to these needs? In other words, what if we could measure a great company?
Arbitrary factors can be measurable if we elucidate their value from a combination of related elements that can be scored.
Last week, finnCap Chairman and founder of Better Capital Jon Moulton hosted the second edition of our ‘In Session With…’ series of events, to talk about the winning companies of AIM and what defines them. In so doing, we looked at how to answer the question of what makes a great AIM company in a way more grounded in science.
For this, the conversation turned first to finnCap’s Head of Research Raymond Greaves to explain how our proprietary Slide Rule equity analysis tool does just that. The basic premise of using Slide Rule is that more arbitrary factors – like an impressive management team – can be measurable if we elucidate their value from a combination of related elements that can be scored.
The fundamental premise is that a great company is one that generates strong and sustained returns to shareholders.
How does one determine the best companies? We came up with 11 key factors on which to rank a company, which we categorise under four ‘buckets’ – quality (Q), value (V), growth (G) and momentum (M).
So, for instance, return on capital employed (ROCE) will fall under the quality measure, price earnings ratio under value, sales and EBIT growth are measures of growth, and changes in earnings estimates will be an indicator of momentum.
The Slide Rule makes the fundamental premise that a great company is one that generates strong and sustained returns to shareholders. We studied a model portfolio of the 30 top-ranked stocks in each of our four buckets – Q, V, G and M – and back-tested their performances from the start of 2014 until the present day. The benchmark we used was the average of the AIM All-Share and FTSE Small Cap indices.
The value and growth stock portfolios outperformed the benchmark by a modest amount, the quality portfolio significantly more since the start of 2017, and the momentum portfolio performed significantly better than the others since the start of 2016.
The right blend
We then studied returns from a mix of stocks from each of the four buckets. What we found was that a blend of all the QVGM factors produced the best absolute and risk adjusted returns. This is the approach that we have distilled into a fund that one can buy – the MortLake finnCap Slide Rule Fund.
Our studies using Slide Rule show conclusively that companies demonstrating strong growth prospects, that consistently meet and beat expectations, and that show a consistently high ROCE, deliver the best shareholder returns.
It is these companies that we can confidently say have a management team in place with the right priorities front of mind.
The Slide Rule was used to define the finnCap Ambition Nation Listed 50, which identifies the 50 leading smaller UK-listed companies that offer the best blend of growth and quality. Find out more here.