Small-Cap High Flyers Soared In 2017 - But How Do You Find Them?

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Includes: AMSJF, AVNBF, DOTDF, PLRRF, SSPPF, TFSTF, TSNLF, VTXPY, XPPLF, YUGVF
by: Stockopedia

It has been a terrific year for many UK smaller quoted companies. With just a few days left in 2017, the Alternative Investment Market has notched up a 20 percent gain, and the FTSE SmallCap is up by nearly 10 percent.

But while the returns have been impressive, smaller companies still present their own challenges. There are more than a thousand shares across the smaller-cap indices. So there's an ever-present need to avoid risky, low probability stocks and be wary, too, of popular shares where strong momentum isn't supported by anything more than enthusiastic sentiment.

One strategy that tackles these challenges and has worked very well in 2017 is to focus on shares where strong momentum is underpinned by high quality. In the Stockopedia lexicon, these are the market's High Flyers.

The hallmarks of a High Flyer

High Flyers are one of the categories in our framework of "styles" that's based on the exposure of shares to high Quality, attractive Value and strong Momentum.

High Flyers have a very distinctive profile. For a start, they are good quality, in terms of both their franchise and financial strength. Good quality companies are highly profitable with strong, industry-leading margins. They are stable, growing and often have accelerating sales and earnings. They also have strong and improving financial histories and no signs of accountancy or bankruptcy risk.

In addition, High Flyers have strong momentum both in the price of their shares but also in their track records of earnings growth. It shows up in stocks trading at or above their 52-week highest prices and are performing strongly against the rest of the market. They'll often be beating broker estimates and receiving forecast upgrades and recommendation changes.

The catch with high-quality, strong momentum shares is that the market finds these features very desirable. So these kinds of stocks rarely look cheap, and that can be a deterrent to many investors.

If you took this High Flyer approach to large- and mid-cap companies right now, you'd be looking at stocks like SSP (OTC:SSPPF), XP Power (OTCPK:XPPLF), Advanced Medical Solutions (OTC:AMSJF) and Victrex (OTC:VTXPY). These companies have robust financial strength and solid performance histories, but their price charts give away just how much the market values these characteristics. The momentum in these shares can be breathtaking.

How small-cap High Flyers performed

But what about High Flying smaller companies? Stockopedia users will know that we keep a keen eye on the performance of the StockRank Styles, and High Flying small Caps have done very well this year - with stocks in the £50-350 band returning an excellent 30.6 percent. The chart below shows how baskets of stocks with the highest QM exposure have performed over that period:

Applied to fast-paced smaller company indices like AIM and the FTSE SmallCap, these are the sorts of companies we're seeing at the moment.

Name

Mkt Cap £m

QM Rank

Value Rank

Pc Price Chg 1y

Sector

Exchange

Polar Capital (OTC:PLRRF)

492

99

32

+74.1

Financials

AIM

Majestic Wine

319.4

99

21

+47.1

Defensives

AIM

dotDigital (OTC:DOTDF)

282.5

99

6

+69.8

Technology

AIM

Mortgage Advice Bureau

281.6

99

31

+69.1

Financials

AIM

Avon Rubber (OTCPK:AVNBF)

376

99

30

+15.6

Industrials

LSE Main

Gooch & Housego

372.1

99

13

+56.8

Industrials

AIM

Focusrite

186

98

23

+40.0

Technology

AIM

YouGov (OTCPK:YUGVF)

337

98

13

+28.0

Cyclicals

AIM

Tristel (OTC:TSNLF)

109.9

97

14

+58.6

Industrials

AIM

Trifast (OTC:TFSTF)

302.8

97

32

+26.9

Industrials

LSE Main

By their nature, the Value Ranks of these High Flyer stocks are relatively low, bearing in mind the ranking ranges from zero (very expensive) to 100 (very cheap). But the combined quality and momentum scores are very high.

One of the arguments in favour of looking for High Flyers among small companies is that the large companies of tomorrow are most likely to be found in this territory. So knowing what to look for, and catching these companies early, can potentially offer a big advantage.

But it's also true that small companies can fail more easily than larger firms, so it's important to be careful. Likewise, quality can deteriorate in some businesses, and strong momentum can collapse if the story changes. But paying a higher price for better quality shares on the move is a proven strategy of playing two very powerful drivers of returns in the stock market. High Flyers won't fly high forever, but they can deliver stunning returns over long periods.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.