3 Market Segments We Like, and How to Invest in Them

The market's strong opening to 2012--with the S&P 500 up more than 9% since the calendar turned--has caused some investors to wonder whether stocks are no longer attractively priced. But even investors worried that the market has nowhere to go but down might find opportunity in sectors and fund categories that still appear undervalued, if not quite as enticing as they were during last fall's market correction. 

Using market fair value sector estimates made by Morningstar's equity analyst team and the  ETF Valuation Quickrank tool, which uses those same estimates and applies them to exchange-traded funds, we looked for high-quality stocks, ETFs, and mutual funds focused on attractively valued areas of the market. Here are a few of the areas we found, with investment ideas for each.

Energy
Don't let high gas prices fool you: Energy stocks remain about 14% undervalued, according to Morningstar analysts tracking the sector. The economies of Europe and China, key drivers of energy consumption globally, continue to sputter, while natural gas surpluses here in the United States have brought prices down considerably. Morningstar's director of equity research for energy, Jason Stevens, says some exploration and production companies, in particular, remain attractively valued, and he likes  Ultra Petroleum ,  Devon Energy (DVN), and  Peyto Exploration & Development (PEY), among others. For those seeking broader exposure to the sector, our ETF team likes  Vanguard Energy ETF (VDE), which focuses on oil and natural gas companies up and down the supply chain and tracks the MSCI U.S. Investable Market Energy Index, with  Energy Select Sector SPDR (XLE) another favorite. Vanguard also offers a mutual fund devoted to the sector,  Vanguard Energy (VGENX), which is actively managed and carries a Gold Morningstar Analyst Rating for its experienced management team and relatively low 0.34% expense ratio (though not as low as the ETFs mentioned here).   

Large Value
It's probably no surprise to hear that there are several attractively valued issues in the large-value category, but based on analyst estimates of stocks that make up the Morningstar Large Value Index, the entire category is currently more than 15% undervalued. Using Morningstar's  Premium Stock Screener tool, we looked for large-value companies with wide moats and Morningstar Ratings for stocks of at least 4 stars, meaning they have significant competitive advantages and are selling at discounts to our analysts' fair value estimates. The list includes blue-chip names such as  Abbott Laboratories (ABT),  General Electric (GE), and  Johnson & Johnson (JNJ), all of which Morningstar's equity analyst team feels are still selling at double-digit discounts. For those interested in investing in large-value stocks through an ETF, there's  Vanguard Value ETF (VTV), which tracks an index of 750 large, slower-growing, value-priced companies. Among several highly rated large-value mutual funds are  Dodge & Cox Stock (DODGX) and  T. Rowe Price Equity Income (PRFDX). The former looks for large-cap stocks with sustainable competitive advantages, while the latter offers a yield tilt to go with its appetite for value.

Financial Services
More than three years after financials led the market's collapse, the sector has yet to fully recover. Financials stocks took a pounding in 2011 amid credit concerns in the U.S. and abroad, with Europe's ongoing woes continuing to stoke uncertainty. Despite a nice rebound so far in 2012, the sector remains about 13% undervalued, according to Morningstar's equity analysts. Jim Sinegal, associate director of Morningstar's financials team, likes the outlook for companies that are positioned to grow and are shielded from changes to their industries, such as  Wells Fargo (WFC),  Western Union (WU), and  Lazard (LAZ). For ETF exposure to financials, our ETF analyst team likes  iShares S&P Global Financials (IXG), a geographically diversified fund that tracks the S&P Global Financials Sector Index and includes nearly 220 financial companies worldwide, with about 60% of the portfolio outside the U.S. It sells at a more modest discount to fair value than the sector as a whole, but no other ETF offers broader exposure to the international financials market. Investors in actively managed funds might want to consider  Davis Financial (RPFGX), a Warren Buffett-styled fund offering an experienced management team and reasonable expenses relative to its peers.

Valuation estimates as of April 24.