Amidst the ongoing tech stock wreck, value shares are everywhere. There’s just one catch…

1) Growth stocks have taken a pummeling these last 12 months, with seemingly no let-up in sight. As witnessed by the fall in the Xero Limited (ASX: XRO) share price today, a high-quality stock that was down 50% over the past 12 months (before today), can still tumble another 11%… and potentially more.

Xero reported revenue grew 31% over the past six months, but that translated into only an 11% increase in earnings before interest, tax, depreciation, and amortisation (EBITDA). Free cash flow was just $NZ15.6 million as the company continues to reinvest to drive long-term shareholder value.

Problem is, when your market capitalisation is close to $10 billion, and in these times of higher interest rates when the market wants to see a decent level of cash generation, a few million dollars of free cash flow isn’t going to pass muster.

To some, Xero may offer value, given the lifetime value of a customer is around seven times its cost of acquisition. But it’s going to take a long time for the company to grow into its valuation, and in this market, patience is not a strong point. It will likely be many years before the Xero share price gets back to the heady days of $150.

2) If ASX growth shares are on the nose, value shares must be the way to go.

There’s no shortage of companies that look like great value, trading on single-digit earnings multiples and very attractive dividend yields.

Data from S&P Capital IQ, P/E multiple based on last twelve months earnings. Dividend yield is historical, not forecast.

If only stock picking was this easy… 

Looking forward, each company has its challenges. When it comes to investing, there’s always a catch.

Commodity prices are hard to predict, and typically the time to buy mining stocks is at the bottom of the cycle, not near the top, as is the case now due to booming oil, iron ore and coal prices.

Retailers have some serious headwinds ahead as sharply higher interest rates start to put a bite on retail spending. As to what extent, we’re all just guessing at this stage.

By lengthening your time horizon, you put the odds more in your favour. 

Will JB Hi-Fi be generating higher profits in five years’ time than now? You’d imagine so, but how much higher? Only 20% higher translates into a less than 4% compound annual growth rate (CAGR). But 50% higher is a much more attractive 8.5% CAGR, with dividends on top. Any expansion in its earnings multiple would be jam on top of the cake.

Obviously, Magellan Financial Group will not be trading on a forecast dividend yield of anything like 18.5%. Its forward dividend yield could be closer to 0%. Will we look back five years from now at Magellan’s enterprise value of around $700 million versus its funds under management of $50 billion and think this is a value stock? Maybe.

3) Even legendary value investor Anton Tagliaferro is struggling to find obvious value.

Interviewed by Livewire Markets, the founder of Investors Mutual said with the recent stock market rally, it’s become more difficult to uncover the value gems.

Tagliaferro says Aurizon Holdings Ltd (ASX: AZJ) continues to impress, saying the rail haulage company has very stable revenues with long-term contracts. 

“Obviously, the coal sector’s doing very well, so its customers are doing very well, which helps when you’re negotiating prices. And Aurizon has a very good management team.”

While, on a trailing basis, not as cheap as the companies listed above, this ASX share trades on a modest 14.5 times earnings and a trailing franked dividend yield of 5.8%.

The post Amidst the ongoing tech stock wreck, value shares are everywhere. There’s just one catch… appeared first on The Motley Fool Australia.

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More reading

• Don’t panic! Here are 7 reasons we can avoid a recession: AMP
• Why Block, Lake Resources, Pendal, and Xero shares are dropping today
• China’s property crash has decimated the iron ore price. So what’s the outlook for Rio Tinto shares?
• Own BHP shares? Here are key takeaways from the miner’s AGM
• Why is the Woodside share price being whittled away today?

Motley Fool contributor Bruce Jackson has positions in Xero. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended ADAIRS FPO and Xero. The Motley Fool Australia has positions in and has recommended ADAIRS FPO and Xero. The Motley Fool Australia has recommended Aurizon Holdings Limited and JB Hi-Fi Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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