Wide-Moat Stocks Tossed in the Bargain Bin

Stocks lost ground during the third quarter of 2015, but it's hard to call it a drubbing. Over the 13-week period ended Oct. 1, the S&P 500 lost around 6.5%, and the Dow and the Nasdaq each shed around 7%. Considering that equities were pretty fully valued or, in many cases, overvalued as the quarter began, a minor correction wasn't really enough to push the market into bargain territory.

And indeed, after the third-quarter dust has settled a bit, the median stock in Morningstar's coverage universe is still close to fairly valued, at 0.95. Still, there are some pockets of opportunity among specific firms.

We used

to sift through our coverage universe to find high-conviction picks that had sold off the most during the third quarter. The required return for stocks in our screen was less than 0% in the past three months (this encompassed the third and fourth quartiles in terms of stock performance). To find firms with sustainable competitive advantages, we added the criterion that firms have wide economic moats. We then screened for stocks that were trading in 4- or 5-star territory. We added a final criterion, stocks with fair value uncertainty of medium or low, to find the equities with fair value estimates in which we are most confident.

As of Oct. 13, 62 stocks made the screen. Premium Members can view the complete results of the screen by

. We've highlighted a few of our high-conviction picks below.

The pharma and biotech sectors have recently faced significant market weakness, largely because of recent headlines about price gouging, strong policy positions from presidential candidates, notably Hillary Clinton, and congressional investigations into drug pricing, said equity strategist Karen Andersen in a recent Stock Analyst Report. But the pullback has created some opportunities for potential investors, in Andersen's opinion. Wide-moat Biogen remains among Morningstar analysts' best ideas in the sector due to its diversified portfolio and innovative pipeline--and, in particular, the firm's growing profitability in the multiple-sclerosis market.

Monsanto shares have gotten drubbed lately as the firm reported weaker-than-expected fourth-quarter results, alongside plans to eliminate 2,600 jobs. In particular, the company is facing headwinds from currency, elevated costs, and lower glyphosate pricing, notes senior equity analyst Jeffrey Stafford. "Although these factors are likely to hold back growth in 2016, we don't think they damage Monsanto's long-term growth prospects. Notably, management is sticking to its long-term target to more than double earnings per share from 2014 to 2019. We think this speaks to the competitive positioning of Monsanto's products and the opportunities for seed-technology growth, given necessary yield improvements globally," he said.

Amid a challenging macro environment, Applied Materials' management reported weak third-quarter earnings results and adjusted fourth-quarter revenue guidance downward. For the past few months, shares of the semiconductor-equipment supplier have been in the dumps. But equity analyst Abhinav Davuluri believes that Applied's competitive advantage remains intact due to its position as the top vendor in the semiconductor-equipment market, and at 4 stars, the share price represents an opportunity for long-term investors. Though he notes that the cyclical nature of the chip industry, as well as the display and solar markets, is a ubiquitous threat to equipment suppliers, Davuluri believes "Applied's expansive product portfolio and large installed base will allow the firm to comfortably weather business cycles over time, and [he expects] the company to experience decent growth over the long term."

Diageo's management recently said that unfavorable currency headwinds are likely to weigh on fiscal 2016 operating profits more than previously expected. In fact, a "perfect storm of primarily near-term and one-time problems" has weighed on the stock's performance in recent quarters, according to senior equity analyst Philip Gorham. However, Gorham still has high conviction in Diageo due to the firm's broad brand portfolio and cost advantage. "Diageo has generated at least high-teens returns on invested capital, after adding back goodwill and removing excess cash, every year for more than a decade. We expect this to continue through our five-year forecast period. These returns are well in excess of the firm's weighted average cost of capital, which we estimate to be 8%, and the consistency of the excess returns, even through the financial crisis, lends support to our belief that Diageo possesses a wide economic moat,"

.