2 beaten-up cheap stocks: Are they bargains?

You have to be careful buying stocks that have recently crashed because often there is a good reason the market hates them. However, occasionally high-quality companies get sold off on short-term concerns presenting a buying opportunity for the far-sighted investor. Here are two stocks that are in the doghouse, but are either of them bargains?

Shares of embattled law firm Slater & Gordon Limited (ASX: SGH) are down a heart-stopping 88% in the last year. The company has a $128.6 million market capitalisation and reported normalised earnings before interest, tax, depreciation, amortisation and movement in work in progress (EBITDAW) of $36.6 million in 2016.

The trouble is that EBITDAW (a metric that I have never come across before) doesn’t tell us anything about how much cash Slaters generates, the key factor when valuing a company. In fact, the business burnt through $104.2 million of operating cash in 2016 and has $682.3 million of net debt.

Based on its 2016 figures Slater is heavily indebted and draining cash at a staggering rate which is pretty much the opposite of what I look for in an investment. Its $128.6 million market capitalisation looks overpriced in my opinion.

Aconex Ltd (ASX: ACX) provides cloud software to the construction industry and its shares are down 14% in the last month. Unlike Slaters the business is going from strength to strength with revenue up 49.8% to $123.4 million in 2016 including 32% from organic growth and rising positive operating cash flows.

Aconex’s Australia and New Zealand (ANZ) division generated $48.8 million of revenue at 71% operating contribution margins in 2016. Operating contribution is defined as earnings before interest, tax, depreciation and amortisation (EBITDA) and excludes head office costs.

The high margins in ANZ show what is possible if Aconex can achieve scale in its less mature overseas divisions. These represent much larger markets and so over time their absolute profits could be much higher than at home.

Perhaps Aconex shares have slipped recently simply because the company was too richly priced. However, despite its $1.3 billion market capitalisation I would rather buy shares in Aconex than Slater & Gordon today.

Personally, I'd forget Slaters and Aconex and take a look at these three blue chips instead. They all pay fully franked dividends and offer the very real prospect of significant capital appreciation. Click here to learn more.

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Motley Fool contributor Matt Brazier has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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