In recent weeks, legendary value investors such as Warren Buffett and Anthony Bolton have suggested it is time to get back into equities, while other commentators are repeatedly pointing out that the best time to invest is at the moment of maximum distress.
After a 60 per cent-plus slump in the value of the Alternative Investment Market (Aim) All-Share index over the past 12 months, it could reasonably be argued that we are at, or close to, the 'moment of maximum distress' for the specialist smaller companies market. The across-the-board sell-off in smaller companies has been indiscriminate and, as a result, some real value has emerged.
There is no guarantee that Aim as a whole will recover, but value investors revel in markets such as these and it is likely that the better-quality Aim companies will see a recovery first.
We ran a series of screening tests to highlight Aim companies with little or no net debt, strong free cash flow yield and forecast EPS growth over the next 12 months. Through this screening process we have identified six recovery situations whose shares have fallen by 50 per cent or more in the past 12 months.
We also looked further afield to identify genuine special situations where new management may be turning around a former dog or the current economic malaise is creating short-term opportunities that should lead to an uplift in fortunes.
Equity markets are likely to remain volatile for some time and confidence in Aim has taken a particularly hard knock. But buying now, albeit a high-risk strategy, could produce the highest rewards.
When the market starts to recover, undervalued, quality stocks with good earnings streams and strong balance sheets should be the first to benefit. We can't predict when a turn in investor confidence will happen, but markets generally front-run economic recovery by some months, if not quarters. Recovery investing is high-risk, high-reward stuff and, for those investors with a strong enough constitution, it can be a valuable strategy. Just be prepared for a roller coaster ride along the way.
See also: Shares for the recession, which focuses more on defensive shares.
