Focus on the Basics With These Investment Ideas

This year's strong market performance has made bargain-hunting a challenge. But even though stocks in general seem to be fairly or even slightly overvalued, there are a few sectors that still appear at least modestly undervalued, as measured by our equity analysts' fair value estimates.

A visit to our Market Fair Value page shows stocks overall hovering just above the fully valued mark these days. But by clicking the sector tab along the left-hand rail and then clicking on each sector listed, you'll find that two somewhat related areas--basic materials and energy--remain slightly undervalued. These sectors encompass a broad array of companies producing a wide variety of goods, including oil and gas, metals, building materials, chemicals, and agricultural products. Each industry within these sectors has its own unique dynamics, and you can read about what's happening in them in our latest quarterly outlook reports. The outlook for basic materials can be found here and for energy here. Among the macroeconomic themes affecting these sectors is slower-than-anticipated growth in emerging markets, particularly China, which has damped expected demand for raw materials. On the energy side, growth in U.S. oil production and ongoing turmoil in parts of the Middle East and Africa make for a cloudy outlook.

For investors interested in tapping into either the basic materials or energy sectors, there are a variety of ways to do this. One of the most straightforward is to use a broadly diversified fund (or group of funds) to do the job; a check of your portfolio's X-Ray on Morningstar.com will show you how much you have in each sector. If your portfolio's weighting is in line with, or higher than, the S&P 500's, you might not need or want to layer on additional exposure.

If you find that you're light on these potentially undervalued sectors, however, you might consider investing in a mutual fund or exchange-traded fund that focuses on one of these sectors.  iShares Global Materials ETF (MXI), for example, is an ETF that tracks all the materials stocks in the S&P Global 1200 Index. For energy exposure,  Vanguard Energy ETF (VDE) is a fine choice and tracks the MSCI U.S. Investable Market Energy Index.  

Fund investors have some good choices, as well. For those looking for actively managed exposure to basic materials,  RS Global Natural Resources (RSNRX), which carries a Silver Morningstar Analyst Rating, offers a management team focused on low-cost producers in the natural-resources arena (at 1.45% in annual expenses, it's also quite a bit more expensive than the index ETF alternatives, and it may come with a load). 

For those looking for direct exposure to undervalued companies in the basic materials or energy sectors, our  Premium Stock Screener tool can help. We've set the tool to screen for companies in the basic materials and energy sectors that currently carry Morningstar Ratings for stocks of 4 or 5 stars, meaning they are trading at discounts to our analysts' fair value estimates. We also want to make sure these companies have narrow or wide Morningstar Economic Moat Ratings, meaning the firms have at least some sustainable competitive advantages. Additionally, we've screened out companies with high fair value uncertainty ratings in order to focus on stocks whose ratings our analysts consider to be more reliable given the volatility inherent in these sectors. Our list can be seen  here if you are a Premium Member, and, as always, you can customize it by changing any of the screen components.

At present the only stocks that meet all the above criteria are from the oil and gas or industrial metals and minerals industries. Below are two names on the list.

 Enbridge (ENB)       
| Moat Rating: Wide | Fair Value Uncertainty: Low      
This North American pipeline operator currently carries a wide moat rating because of the regulated nature of its assets, ability to lock out competing pipelines in some areas, and growth prospects, says Morningstar equity analyst David McColl. Enbridge is a dominant player in Canada's oil sands region and growing its position in the Bakken shale play. Among the risk factors for the company are the potential for slowing production in these areas as well as the risk of pipeline leaks--faced by the whole industry--which can bring increased scrutiny and regulation, increasing maintenance costs. Earnings growth for 2014 is expected to be weak before picking up in 2015-17. The stock yields about 3%.

 BHP Billiton      
| Moat Rating: Narrow | Fair Value Uncertainty: Medium    
This Australian mining giant's narrow moat rating is attributed to its low-cost operations, particularly in iron ore and petroleum, says Morningstar's Mark Taylor. Despite operating in an inherently risky industry, the company's commodity and geographic diversification and low-cost positions reduce its risk profile relative to its peers. However, cooling demand for commodities remains a risk here, as do the environmental and operational risks associated with the mining industry. The stock's yield currently stands near 4%.