Buying shares on 3x earnings is a great way to get rich – Here's how!

It requires patience but it is possible.

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Keen investors who kept an eye on the US market during the Global Financial Crisis (GFC) would have been hard pressed not to read or hear about hotshot hedge fund manager David Einhorn who accurately predicted the implosion of sub-prime mortgages and in the process made literally billions of dollars for himself and his investors.

I recently read a speech that Einhorn gave back in 2005 in which he made the following comment:

"If the PE is 3 and the expected growth rate is 1, I would conclude that it is an obvious bargain, as paying 3 times earnings that are stable is a great way to make a fortune."

Einhorn may be right that buying stocks trading on a three times price-to-earnings (PE) multiple is a great way to get rich but of course they aren't easy to find. In fact, few stocks ever trade on such low multiples, and importantly aren't too dangerous to touch except perhaps in the depths of a market crash.

Einhorn is not alone in his quest to purchase cheap stocks; some of the top Australian-based fund managers including Perpetual Limited (ASX: PPT) and Platinum Asset Management Limited (ASX: PTM) have a value bias too. Rarely would these massive funds have the opportunity to buy stocks on such low multiples. However, the simple fact is that often these opportunities sometimes arise amongst small capitalisation stocks, which puts the individual investor at an advantage over the institutions.

Although I've had to expand the parameter slightly, here are three companies trading on very low PE multiples that investors with a value mindset might consider taking a closer look at.

    1. Diploma Group Limited (ASX: DGX) is a Western Australian-focussed commercial construction and property development business. The company has recently won some substantial contracts and reaffirmed guidance for the full year of earnings before interest and tax of $7 million. This should equate to around 0.8 cents per share (cps) on a fully diluted basis. With the stock trading at four cents this implies a PE of 5x.
    2. Macmahon Holdings Limited (ASX: MAH) provides engineering solution to the mining industry. Its business has been affected by the significant slowdown experienced by the resource sector. In turn the company's earnings are forecast (according to research from Morningstar) to fall in FY 2014. While the company's earnings are forecast to fall in FY 2014 and again in FY 2015, if investors have confidence that the decline can be reversed or stabilised they could purchase the stock on a FY 2015 PE of 5x.
    3. OTOC FPO (ASX: OTC) also operates in the mining, energy and infrastructure services space. Annualising OTOC's half-year results suggests the company could earn 2.8 cps for FY 2014. With the share price at 11 cents this implies a PE of 3.9x.


Motley Fool contributor Tim McArthur owns shares in Perpetual Ltd and OTOC FPO.

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