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After Deliveroo’s IPO flop, how do you back a stock that will blossom?

The takeaway titan Deliveroo made headlines with its stock market debut last week – although not for the reasons it had hoped.

Within hours of joining the market, its share price had fallen 30 per cent.

The price may recover, but it remains one of the weakest IPOs (initial public offerings) in FTSE history.

Float flop: Within hours of joining the market last week, Deliveroo’s share price had fallen 30 per cent

Given that the company had been named by the Chancellor as a true British success story, market-watchers can be forgiven for feeling disappointed.

Certainly, any Deliveroo customers who took advantage of the platform’s exclusive share offer will be feeling out of pocket.

So is the Deliveroo flop a cautionary tale for investors chasing fast-growing companies? Or just a case of backing the wrong horse?

Great expectations

‘Deliveroo isn’t the first firm to experience a rocky start,’ says Danni Hewson of investment platform AJ Bell.

The likes of Uber and Facebook both had underwhelming IPOs, yet have performed strongly since.

Either way, last week’s events have delivered a jolt to our sky-high expectations of certain growth stocks. Of course, Deliveroo was far from a plucky start-up. But its valuation had risen sharply on the back of a tech rally which took hold last year.

The big question for Deliveroo is whether it can continue to expand, in particular beyond London.

The response of many big investors — some of whom publicly snubbed Deliveroo before its IPO – suggests they’re unconvinced.

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But markets don’t always get it right. Take grocery delivery service Ocado, which recorded one of the worst IPOs on record back in 2010. After a poor start, the company has boomed, with shares doubling in value more than 12 times.

Picking a winner

Ocado is one of several portfolio darlings which have delighted investors in recent years.

Retailer JD Sports and construction supplier Ashtead both enjoyed long spells as ‘must-have’ shares. 

In the past five years, they have returned 273 per cent and 433 per cent respectively. Over ten years, JD Sports has delivered 1,800 per cent.

Of course, finding the next big thing is risky and very difficult.

It can often involve investing in much smaller companies – including from the FTSE’s Alternative Investment Market (AIM).

The index is typically home to so-called microcaps: companies worth less than £250 million.

After several years out of favour, AIM is enjoying its moment in the sun. Last year, it was among the fastest-growing stock markets in the world, performing twice as well as the FTSE 250.

Data from investment platform Interactive Investor shows that customers are increasingly investing in AIM.

Its companies made up 38 per cent of all customer orders last year. But is it really such a solid bet?

Risks: While the AIM market has delivered its fair share of winners — like online fashion seller ASOS, which recently purchased Topshop — the index is notorious for volatility

Risks: While the AIM market has delivered its fair share of winners — like online fashion seller ASOS, which recently purchased Topshop — the index is notorious for volatility

Tread carefully

Investors in micro-caps want to find up-and-coming firms with the potential for rampant returns. 

But while AIM has delivered its fair share of winners – such as online fashion retailer ASOS, which recently bought Topshop – the index is notoriously volatile.

Take Surrey-based clinical diagnostics manufacturer Novacyt, which lost 90 per cent of its value after joining the index in late 2017.

Then came the pandemic, and Novacyt’s work on Covid tests saw its share price grow by 5,800 per cent in one year alone.

AIM’s start-up focus has made it particularly susceptible to the tech boom, which has left some experienced investors suspicious of its high valuations.

Cryptocurrency-miner Argo Blockchain has been one of the most popular shares among retail investors this year, with its price rising 600 per cent in two months.

But the stock has wobbled considerably since its February high, meaning that those who bought at the peak are 17 per cent down already.

Given these rollercoaster numbers, you can see why even higher-risk investors often choose to seek an expert touch.

Unlike the FTSE, there are no AIM tracker funds (which follow the overall index), only actively-managed funds.

These micro-cap funds identify the companies they believe can thrive, and then spread investors’ money across different options.

High performers

Marlborough UK Micro-cap Growth is a popular fund with investors interested in up-and-coming companies.

The fund has returned 123 per cent over five years, making a £10,000 investment worth £22,300.

For a micro-cap fund, it has also achieved the difficult feat of keeping its growth largely consistent from year-to-year.

Its current holdings include green engineering companies, a waste management business (Augean), and audio-recording product specialists Focusrite.

TB Amati UK Smaller Companies fund currently appears on Hargreaves Lansdown’s shortlisted funds. £10,000 invested five years ago would be worth slightly more than the Marlborough, at £23,000.

Its investments include an artificial intelligence clinical diagnostics company (RenalytixAI) and Sheffield-based video firm Sumo Digital.

Of course, many of these businesses won’t have the track record of Deliveroo, and certainly won’t have the same level of private backing.

If one of these falls into trouble, its shares are likely to fall more rapidly than a larger FTSE company – enough to dent the fund’s performance.

Still, for investors happy to take the risk (at least with some of their capital) they may prove to be just the ticket.

moneymail@dailymail.co.uk

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