5 top tips to avoid losing your shirt on AIM stocks

These tips could help you find AIM’s (INDEXFTSE:AXX) big winners and avoid its disaster stocks.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The more than 900 companies on London’s AIM market have the potential to deliver life-changing profits for investors. A prime example is Asos, now AIM’s biggest company, which has turned £1,000 into £2.95m since floating in 2001.

However, despite some huge individual winners, the AIM index is no higher today than its launch value of 1,000 points in 1995. Hundreds of companies have come and gone over the years and the majority have been utter disasters for investors.

Here are my five top tips to avoid losing your shirt on AIM and increase your chances of finding one of the big long-term winners.

Tip #1 – Check directors’ histories

As legendary investor Warren Buffett says, integrity is the single most important quality to look for in business managers. Without it, the other desirable qualities of intelligence and energy will kill you.

Seek out independent verification of the backgrounds and CVs of AIM directors. Stay away from directors with histories of serial business failure, or who’ve been investigated for or convicted of any financial wrongdoing, or whose CVs cross the boundary from embellishment into fabrication.

In addition to a general internet search, the Companies House website is a great resource.

Tip #2 – Learn about creative and fraudulent accounting

Investing time learning about company accounts should repay you in the long run. In particular, knowledge of accounting shenanigans can steer you away from potential disasters-in-waiting.

There are numerous ways companies can cook the books. An internet search for aggressive accountingwill take you to sources for learning about the signs of potentially creative or fraudulent accounting. The more “red flags” a company’s accounts contain, the higher the risk there’s something seriously wrong. Erring on the side of caution is prudent.

Tip #3 – Accept nothing less than clear and honest communication

As shareholders, we are part-owners of any company we invest in. And we should expect to receive — in addition to accurate accounts — clear and honest communication from those we’ve tasked with managing our business (the directors).

Companies that tel outright lies, that lie by omission or otherwise mislead shareholders in annual reports and other regulatory statements, at AGMs or in informal press or online interviews should be given short shrift.

Tip #4 – If it looks too good to be true…

If a company is trading on a ridiculously cheap valuation, you should take it as a warning to steer well clear, rather than as an invitation to pile in.

In particular, I’ve never known anything other than a bad outcome for investors buying a company trading at a large discount to net cash (that’s to say, when its market cap is a small fraction of the net cash on its balance sheet). The market is essentially signalling that it doesn’t believe the cash is there and that the company is an outright fraud. If a valuation looks too good to be true, it probably is.

Tip #5 – Diversify

Even if you follow tips one through four, it’s the nature of the small-cap universe that even good, well-managed businesses can encounter serious problems or even go under. As such, you can lose your shirt by going all-in on a single stock or a very small number. Diversifying your AIM portfolio across a range of companies will not only decrease the risk of you being wiped out, but also increase your chances of alighting on one of the market’s life-changing winners.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

These FTSE 100 shares could soar over the next year

FTSE 100 shares show strong potential as rate cuts loom. History shows stocks could gain more than 70% in the…

Read more »

Young Black woman using a debit card at an ATM to withdraw money
Investing Articles

“If I’d put £5,000 into Santander shares just 2 years ago, here’s what I’d have now”

Our writer considers whether he thinks Santander shares still look good value after a strong period for the global Spanish…

Read more »

Illustration of flames over a black background
Investing Articles

Could this FTSE 250 stock be the next Rolls-Royce?

With an ongoing probe into the motor finance industry, the share price of this member of the FTSE 250 has…

Read more »

Investing Articles

My 3 favourite FTSE dividend stocks give me a mind-blowing 9.82% yield!

Harvey Jones is surprised to learn that he owns the three highest-yielding dividend stocks on the FTSE 100. So is…

Read more »

Investing Articles

Following strong 2024 results, this 6.1%-yielding FTSE 100 gem looks a bargain to me

With good 2024 results delivered, and a buyback and dividend increase announced, this high-yielding FTSE 100 heavyweight looks very cheap…

Read more »

Investing Articles

I’m not surprised the IAG share price is surging, it’s the top-rated UK stock

The IAG share price is up 57% since the start of the year, but remains undervalued. This bull run could…

Read more »

Investing Articles

Is the stock market set for a crash in 2025?

Could antitrust lawsuits derail US tech stocks and cause a stock market crash next year? Stephen Wright thinks the risks…

Read more »

Investing Articles

As Rolls-Royce’s share price falls 8%, is it time for me to buy on the dip?

Rolls-Royce’s share price has dropped after a stellar rise this year. I think this leaves it looking even more discounted…

Read more »