Elliott Davis finds a raft of Aim companies offering great growth potential and attractive dividend yields

Aim may not be the obvious destination for investors looking for dividend income, but this simple fact should give you pause for thought – nearly 20 per cent of Aim companies pay dividends.

Once you recover from the initial shock, this fact isn't really that surprising, considering the size and maturity of the market. Set up in 1995 as the home for young and growing business, it has expanded at a phenomenal rate (there are now over 700 companies) and morphed into a thriving dynamic market in its own right.

Profit generating giants co-exist alongside loss-making micro-caps while blue-sky techno projects jostle for investors attention with mundane manufacturers. It is, in every sense of the phrase, a broad investment church with a diversity of investment options to rival the Full List. But just like the Full List, not every company that sports a tantalising income yield on Aim is worth pursuing.

Six to stash away

In our opinion, James Halstead and agricultural services conglomerate NWF remain the pick of Aim's high yielding stocks

Latest full year figures from the pair once again revealed record profits (£11.3 million at Halstead and £4.2 million at NWF), which lead, in each case, to further increases in dividend payments. The duo now offer yields of 5.3 per cent and 4.9 per cent respectively and are expected to improve sales, profits and dividends in 2002/03.

Of the two, Halstead offers greater security thanks to a near £14 million cash pile. NWF, by contrast, has debts in excess of £10 million, though it does cover its dividend more than three times with earnings.

Those looking for steady, if not spectacular, income allied to strong growth prospects, meanwhile, should consider ComputerLand, one of this month's Company Watch recommendations (see page 3). ComputerLand is expected to produce a return of roughly three per cent for the current year and finance director Mike Kent says management is committed to paying a dividend it can cover three times, so there is ample room for further growth.

Much the same can be said of pawnbroker Albemarle & Bond and video rental firm Home Entertainment, which currently sit on well-covered yields of 2.9 per cent and 3.3 per cent respectively.

Broker Seymour Pierce expects both Albemarle and Home Entertainment to record steady growth over the next two years and reckons dividend payments should edge up accordingly – analyst Ryhs Williams believes that Albermarle, in particular, looks interesting from a growth and income perspective.

Williams' argument is that the pawnbroking business is 'largely counter-cyclical'. In bear markets, people consider alternative methods of loaning cash, which suggests that the present market conditions are in its favour. Recent forecasts suggest Albermarle will yield 3.4 per cent for the current year, while Home Entertainment is expected to provide income of 3.8 per cent.

If you're looking for very low risk, reasonable income, take a look at animal health and pet products supplier Lawrence. Expectations are for a 3.4 per cent yield this year and analyst Robert Corden, from house broker Charles Stanley, describes the company as 'the lowest risk growth stock I know'.

David Pannell from Durlacher is almost equally bullish, albeit from a value position. He believes the firm is already worth nearly £15 million more than its existing market valuation.

Lawrence's ECO Animal Health division is the cause for his excitement. ECO has spent eight years developing two products. The first is an anti-parasite drug called Ecomectin, now gradually receiving approval in Europe and the US. The second is a respiratory drug called AIVLOSIN, which is set to receive the commercial green light either later this year or in early 2004.

Pannell believes that in 2007 the latter alone could generate annual revenues of more than £80 million for Lawrence.

Expected to improve profits before tax from £761,000 to £4 million in the year to March, with earnings of 12p, Lawrence looks good value for those interested in both income and considerable capital growth.

Speculative stocks, higher yields?

While the firms highlighted above offer fairly reliable income streams there are, of course, greater yields available for those prepared to accept more risk.

Electronics manufacturing services group Stadium is a prime example. The firm dropped from the Full List to Aim in July 2001 as a first step in its bid for reinvention. It then set about a restructuring programme, which has seen it offload its under-performing consumer products and plastics divisions as well as several freehold sites.

In the six months to June, Stadium cut losses from £6.3 million to £917,000, reduced debts from £11.1 million to £5.2 million and maintained an interim dividend of 0.95p. If, as is expected, the company also maintains last year's final dividend payment of 1.85p, the shares will once again yield eight per cent.

Sofa manufacturer Collins & Hayes is another sitting on a hefty historic yield, of 7.6 per cent. Despite a relatively flat first half (and debts of £8.5 million born out of its demerger from Aquarius, which are gradually being reduced) the Sussex-based firm is expected to at least maintain this level in 2003.

Much the same can be said of office fit-out and facilities management specialist Interior Services, though Sophie Tomkins of house broker Collins Stewart notes full year profits before goodwill will be slightly below the £8.1 million achieved in 2002 due to a well documented slowdown in spending among City firms.

For the year to June, Tomkins expects a total dividend of 6.8p (increased from 6.5p) – a payout likely to be easily covered by more than three times earnings and ample cash reserves.

On a cautionary note, however, there are doubts as to whether Interior Services will continue to make such large payouts in future.

While a bout of corporate belt tightening has held Interior Services back it has given recruitment firm Fairplace Consulting a timely boost – so much so in fact that the shares now yield a tempting 4.8 per cent.

Fairplace's most recent full year results credited record levels of City business for a 450 per cent rise in pre-tax profits to £536,841 and the accompanying 18 per cent increase in revenues to £5.3 million.

It seems that more and more firms are offering outplacement services in a bid to soften the blow to those being made redundant. With this trend said to be continuing, house broker Williams de Broe anticipates further increases in profits and dividends in 2002/03.

Having reinvented itself through the acquisition of TPC Telecom back in August 2001, prize promotions business Invox has also emerged as a rather unlikely income provider. The TPC acquisition radically transformed the last set of figures, blasting revenues up from £104,000 to £13.3 million and enabling the firm to transform a £1 million loss into a £2.6 million pre-tax profit.

Last year Invox paid a total dividend of 0.07p and while this may seem rather paltry, at a current share price of 1.62p, it converts to yield of 4.3 per cent.

As for the dividend policy, finance director Jerry Reidy states that 'we have never come out with a formal pronouncement,' but he does admit that 'our view is that while we keep generating profits and cash and remain debt free we should provide a decent return.'

Others that could reward the speculative are instrumentation and medical devices supplier Hartest, yet to prove itself but with bags of potential; construction, property and investment business Montpellier; and electronic components distributor Solid State Supplies.

Avoid anomalies

There remains one piece of advice investors must heed when hunting for income – if it seems too go good to be true it probably is! You just need to look at the very highest Aim yielders to find evidence for this.

With its business beginning to struggle graphic design and print firm Thomas Potts reduced its final dividend payout from 0.17p to 0.085p at the time of its latest full year report and the subsequent crash in shares has driven its historic yield up to 32 per cent.

Since the year-end though, Potts' predicament has only worsened. Interim profits turned to losses, the company's silk screen and lithographic printing arms were both sold off and interim dividends were scrapped altogether. Potts now intends to withdraw from Aim.

Having run up losses of £8.4 million (£3 million profit) and seen debts rise to £17.5 million in the six months to June, engineering business Surface Technology Systems (15.8 per cent yield) is another which looks best avoided. Investors should also steer clear of fellow high yielders Artisan and Charterhouse Communications for similar reasons.

Meanwhile, several companies, though not as troubled as Thomas Potts or as indebted as Surface Technology, simply look unappealing investments.

Textiles business Downtex continues to make a small loss and does not expect things to improve this year.

Metal processing and engineering firm Norman Hay recently retained its 1p interim dividend payout but warned 'dramatic increases in insurance premiums, employment taxation and energy taxes' will hinder its performance for the remainder of this year and the next. Dispute resolution and loss-adjusting outfit James R Knowles has reported tough trading conditions in several of its markets and should be left alone for the time being.

The dangers of backing a firm paying massive yields is perhaps best illustrated by pub group Old Monk. It boasted a yield of 9.5 per cent, but recently called in the administrators due to concerns over its financial position and crippling debt levels. Old Monk has now sold 16 pubs in the past four months to reduce its borrowings, but retains the rights to its two main brands Old Monk and Springbok Bars.

Fellow pub operator Honeycombe Leisure also looks too risky for income chasers.

Christmas trading was strong and full year profits (to April) are expected to surge from £1.1 million to £2.5 million. However, a forecast dividend of 3p is covered less than two times by earnings and debts in excess of £40 million are very high for a company valued at £13 million.