The value of the Alternative Investment Market has risen by 30% over the past 12 months. That sort of stellar performance is likely to appeal to investors looking for a home for ISA funds this year. But while AIM has numerous attractions, it’s still a potentially risky source of investments. One way of overcoming that is to focus on the market’s better quality dividend paying shares.

Neil Woodford, the popular fund manager, recently wrote that there’s no other piece of information like the dividend that could more accurately reflect what a business really thinks about its current state of health.

For Woodford, the “walk of shame” of cutting dividends is enough to deter most executives from doing so wherever possible. Moreover, those that ratchet up their payouts do so knowing that they’re creating a bigger burden for themselves in the future. So they need to be confident that dividend growth is sustainable.

The appeal of AIM income stocks

AIM was designed to be a market for smaller, growth-oriented stocks. When successful, that can translate into spectacular capital gains for shareholders. But as a consequence, many of these companies are more likely to raise money from investors than distribute spare cash back to them.

But it’s also true that some AIM companies have established themselves as attractive income stocks. When you put that in the context of the market’s tax incentives, there are compelling reasons to take a closer look.

For a start, capital gains and dividends are sheltered from tax inside a wrapper like an ISA (subject to individual circumstances). Plus, there’s no stamp duty payable on most AIM shares, and the majority come with inheritance tax advantages, too.

Around 230 of the 970 companies on AIM pay some sort of dividend. Roughly 110 of them are forecast to yield more than the 2.3% rate of inflation in the next financial year. So how do you begin slicing through these stocks to find some of AIM’s better quality high yielders?

Screening rules for high yield small caps

Income investors tend fall into two camps - those chasing high yield and those chasing long-term dividend growth. But it’s useful to see both of these features in building a picture of an AIM dividend stock. So in filtering the market - using this screen - I’ve looked for a dividend growth streak of at least one year. One year is…

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