Stock Up on Bargain Sectors

To win big on Wall Street, sometimes you've got to swim upstream.

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To win big on Wall Street, sometimes you've got to swim upstream. When jittery traders turn sour on a sector, as they recently have with banks and retailers, they do more than just send stock prices lower—they create pockets of value for investors with the right mix of patience and guts.

These days, no sector is more spooked than financial services, which is down nearly 20 percent this year. But as the credit squeeze has smothered valuations across the board, it has also generated some nice medium-term value plays.

Take US Bancorp, for example. With $228 billion in assets, it's the seventh-largest bank in the country. And last quarter, its return on equity—a key measure of bank performance—came in at 23 percent, outpacing similar-size competitors. But despite US Bancorp's conservative management and modest exposure to subprime loans, its stock is down more than 10 percent this year, and its price-earnings ratio stands at an enticing 12.7. "The baby's been thrown out with the bath water," says Pat Dorsey, Morningstar's equity research director.

BB&T is also the victim of guilt by association. Although this bank with $131 billion in assets has limited subprime exposure and a 14 percent return on equity through its most recent quarter, its stock has plummeted 19 percent this year, pulling its P/E ratio below 13.

Investors willing to shoulder additional risk should consider financial giants JPMorgan Chase and Bank of America. Although both have taken hits in the recent market turmoil, JPMorgan actually increased earnings last quarter. And fabled investor Warren Buffett recently increased his holdings in Bank of America (and US Bancorp).

"Survivors." While both could certainly face more setbacks over the next couple of quarters, JPMorgan and Bank of America have great retail franchises and enough capital to slog through the adverse conditions. "They're definitely survivors," says veteran money manager David Dreman. And with both now trading at P/E ratios of about 10, they're looking cheap.

To diversify your risk in the beaten-down sector, consider an exchange-traded fund like the KBW Bank ETF, which tracks a slew of the nation's largest banks, or the iShares Dow Jones US Financial Services ETF, which provides exposure to brokerages as well.

Meanwhile, growing concerns about a slowing economy and a tough holiday spending season have cut into the retail sector. The S&P retail index has slumped more than 20 percent from midyear highs, making a few high-quality names look tempting.

Teen retailer Urban Outfitters is increasingly appealing, as same-store sales at its Anthropologie and Free People shops soared 17 percent and 16 percent, respectively, in the third quarter, boosting weaker results in its namesake brand. Citigroup recently recommended taking a "hard look" at the company, and its P/E has fallen, too.

Luxury-goods stalwart Tiffany could also be a nice pickup, as wealthy shoppers are more likely to keep spending even if the economy slows further. Affluent foreign tourists looking to capitalize on the weak dollar could give Tiffany earnings a boost. "They're just a solid high-end play," says Brian Sozzi, a retail analyst at Wall Street Strategies.

Should the United States avoid a recession, standout names in the battered department store sector could also work out nicely. With shares of Kohl's having plunged 36 percent from their April peak—and their P/E down to 14—the retail giant is certainly worth considering. "Most of these big-box retailers are priced for a very severe recession, which I don't think we're going to have," says Rob Lloyd, who runs the $2.5 billion AIM Summit Fund.

To diversify risk, consider the Vanguard Consumer Discretionary ETF, which tracks Amazon.com (a notable winner this year as online sales growth outpaces that of bricks-and-mortar stores), Target, and other big names in the downtrodden sector.