a story to consider when buying or trying to buy fep:
By Cliff D'Arcy
October 8, 2004
Earlier this year, I bought my first AIM-listed share. AIM is the Alternative Investment Market, a stock market for small companies, which is much smaller than the the London Stock Exchange's main Official List.
For the record, the share I bought was NewMedia SPARK (LSE: NMS), a cash-rich Internet incubator. This company was featured in the July issue of our Value Investor newsletter, and again in this article on value investing.
However, I was aware of several "issues" when I came to buy my stake in SPARK, some of which are common to all AIM shares:
AIM and ISAs don't mix
You can't buy AIM shares inside a tax-free ISA wrapper, because AIM shares are governed by a different tax regime to main market-listed shares (see below). Unfortunately, I couldn't use the lump of money in my self-select ISA to buy these shares. Instead, I had to transfer extra cash into my dealing account and then buy my stake in SPARK.
Normal Market Sizes can be small
After doing my own research, I decided to put quite a large sum into SPARK. However, I discovered that its Normal Market Size was only 50,000 shares. This means that my broker would charge me a higher buying price if I wanted to buy more than 50,000 shares. As the share price was around 10p at the time, I could only buy shares worth £5,000 at the normal market price. For larger purchases, I'd have to pay a premium.
This is because there aren't that many SPARK shares in circulation. Shares in big, blue-chip companies are easy to buy and sell because there are billions of shares in circulation, plus a lively market of buyers and sellers. However, the same can't be said of small companies, whose shares are often 'illiquid' – difficult to buy and sell in large numbers.
Hence, buying 100,000 SPARK shares (costing £10,000) means buying almost 1/4,500th of the company, which is quite a stake for a private investor. However, on the days when trade is brisk, market makers sometimes increase SPARK's Normal Market Size to 250,000, which means that larger trades (up to £25,000) are easier to process.
Spreads are higher than those of blue-chip shares
SPARK's market capitalisation is a mere £46 million, with around 443 million shares in circulation. Because shares in SPARK don't change hands all that often, market makers could be left with egg on their face if the price moves sharply in response to unexpected news.
In order to cover the risk of being left with small-company shares that they can't shift, market makers increase the 'bid-offer spread' for small firms' shares. For example, the difference between the (higher) buying price – 10.50p and the (lower) selling price for SPARK -- 10.25p -- is 0.25p, almost 2.5%. In contrast, spreads can be under 0.1% for FTSE 100 companies.
Sometimes, my broker can reduce (even halve) the spread on some small-company shares, which saves me a tidy sum now and then. However, thanks to the spread, stamp duty of 0.5% and buying costs, investing in SPARK caused me to lose around 2% of my money on day one. Ouch!
This article explains how low Normal Market Sizes and large spreads can hit your investment returns.
AIM shares get preferential tax treatment
One benefit of buying AIM shares is that they are treated as 'business assets' when it comes to calculating capital gains tax (CGT). What this means is that AIM investors get higher 'taper relief' than holders of Official List shares.
For example, if I sell an AIM share within one year of buying it, I lose two-fifths of my profit (40%) to the taxman. However, this tax bill halves if I wait a year (down to a fifth, or 20%) and again if I wait another year or more (a tenth, or 10%). Thus, if I hang onto my SPARK shares for at least two years, my tax rate on gains falls to just 10%.
On the other hand, I have to hold Official List shares for three years just to get a discount of 5%. After 10 years or more, my tax rate is still a juicy 24%. Yikes!
