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16 Stock Ideas From the Clearance Rack

We found some bargains among stocks that have lost more than a fifth of their value in the past three months.

The U.S. stock market has been a pretty solid performer over the past three months. Though it hasn't really shot the lights out in aggregate, the Morningstar US Market Index has risen 4% over the past three months through July 24. 

It's great for investors when sailing is smooth, but bargain-hunters can have a tougher time in such an environment. To find some opportunities, I searched the companies in our coverage for stocks that have really taken it on the chin in the past 12 weeks. I used our  Premium Stock Screener to find stocks we cover that have fallen more than 20% over the past three months.

The screen returned 41 stocks. Some of them were outliers in an otherwise strong-performing sector, such as beleaguered  Chipotle Mexican Grill (CMG). (Though Chipotle is trading at a discount to its fair value estimate, sector strategist R.J. Hottovy encourages investors wait for a wider margin of safety given the lack of visibility surrounding food safety incidents and subsequent consumer reaction.) 

Not all of the laggards on the list were bargains after their recent sell-off. Some stocks were overpriced to begin with, and others stocks have been under pressure for good reason. (We're looking at you,  Snap (SNAP).)

Two industries that were heavily represented were oil- and gas-related stocks and retailers. Many times when stocks in a sector sell off indiscriminately, there are some bargains to be found. We started there, and sifted through the clearance rack to see if anything looked like a good opportunity at current prices. 

Oil and Gas Stocks
Energy stocks have had a rough go of it, and stocks related to oil and gas exploration and production have had a particularly tough time. A big reason for the downturn is oversupply in the oil markets; in May OPEC and some other non-OPEC countries agreed to extend production cuts for nine months, into early 2018, in an attempt to prop up the oil price.

"The issue is that it is a temporary fix; absent the production cuts, we would still be close to oversupply," said senior equity analyst David Meats. "Sooner or later these volumes will come back to the market. At the same time, production growth from highly efficient U.S. E&Ps will result in additional supply growth. Combining the two could overwhelm oil markets and prevent prices from recovering next year beyond where they are today."

For long-term investors (those with a holding period longer than one year) there are some opportunities. Two of Meats' picks in the sector  RSP Permian  (price/fair value 0.64) and  Diamondback Energy (FANG) (P/FV 0.78), which are at the very low end of the cost curve and have strong enough balance sheets to withstand any near-term volatility in commodity prices. 

"At midcycle prices ($55/bbl WTI) these firms are expected to generate very strong margins," he said. (Neither stock came up in our screen because each has experienced milder losses over the trailing three-month period.)

Of the subset of oil- and gas-related stocks that have lost more than a fifth of their value over the past three months, not all are undervalued. Many are now trading close to fair value, such as  Nabors Industries (NBR) and  Weatherford International , or even overvalued, as is the case with  Transocean (RIG). The following seven stocks are trading at an attractive discount to their fair value estimates.

Retail Stocks
 Amazon's (AMZN) bid to acquire  Whole Foods Market  wreaked havoc on many retailers in the sector. Even  Costco (COST), once thought to have a business model well-insulated from e-commerce threats, has slid since the deal's late-June announcement. Despite the sell-off, though, our analysts see Costco as fairly valued. 

On the other hand, grocery chain  Kroger (KR), the largest traditional grocer in the United States by revenue, has been too harshly punished, in equity analyst John Brick's opinion. The recent sell-off presents investors with an opportunity to pick up the narrow-moat name at a discount.

Amazon has also sent traditional brick-and-mortar clothing retailers into a tailspin with its announcement of Amazon Prime Wardrobe, a service currently in a beta test that will allow Prime members to try on clothing, footwear, and accessory products at home and return unwanted items using a prepaid, pre-addressed box. The two apparel retailers in the list below-- Macy's (M) and  Urban Outfitters (URBN)--have gotten shellacked in the past three months. Though neither firm has an economic moat, both companies have portfolios of defined, recognizable brands and are trading at attractive discounts to their fair value estimates. 

Finally, we see some compelling opportunities among auto-parts retailers on the list. Though equity analyst Zain Akbari notes that there may well be choppiness in the short term, he thinks the sector can withstand digital threats. In particular, he sees  Advance Auto Parts (AAP),  AutoZone (AZO), and  O'Reilly Automotive (ORLY) as good opportunities for long-term investors.

Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.