3 cheap stocks for value investors

Downer EDI Limited (ASX:DOW), RCR Tomlinson Limited (ASX:RCR) and Matrix Composites & Engineering Limited (ASX:MCE) could all potentially provide above average returns to shareholders over the coming years.

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Value investing is actually a very broad term. For some value investors, it is perfectly normal to purchase a stock on a high multiple. For other value investors they will only fish amongst stocks with low single-digit price-to-earnings (PE) multiples.

Can both be right?

As a matter of fact both forms of value investing are perfectly legitimate and can lead to good results over the long term. The key is that in both instances, the investor determines that there is a margin of safety between the price they are paying and the value they are receiving for stocks they buy for their portfolio.

Is either form easier or safer?

The advantage of paying a high multiple is that often you may be more likely to buy a growing, high quality company with good prospects. This may limit your potential for permanent loss of capital, however these types of situations are also more likely to be overpriced which means you potentially run a greater risk of overpaying.

Alternatively, a beaten-up, cheap stock can sometimes offer a more "obvious" margin of safety. The catch is that 'value traps' lurk amongst these types of stocks. This can lead to a permanent loss of capital.

3 potentially undervalued stocks

For investors who choose to focus on 'cheap' stocks, one sector which currently offers an enticing hunting ground for opportunities is the mining services sector. The sector has been badly affected by the slowdown in the resources sector which arguably has created some undervalued investment opportunities.

Here are three companies which are currently trading on low PE multiples that appear to have sustainable business models which should minimise the potential of them turning out to be value traps.

Downer EDI Limited (ASX: DOW) has a reasonably flat earnings outlook according to consensus data provided by Morningstar. Assuming earnings per share (EPS) of 45 cents per share (cps) in FY 2015, investors can purchase Downer on a PE ratio of 10.6x.

RCR Tomlinson Limited (ASX: RCR) had EPS of 33.1 cps in FY 2014 and earnings are forecast to grow to 33.5 cps in FY 2015. With the shares currently priced at $3.40, the stock is trading on a PE multiple of 10.1x.

Matrix Composites & Engineering Limited (ASX: MCE) is expected to see a bounce back in EPS this financial year to 9.9 cps from just 3.2 cps in FY 2014. If the company achieves this consensus forecast, it implies a forward PE multiple of 10.8.

Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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