SmartMoney's Midyear Investment Guide

But maybe his luck is changing. Unable to flee to safer sectors, he turned to names like JPMorgan Chase, U.S. Bancorp and M&T Bank. They were, at the very least, cheap, and since buying the trio in January, his FBR Large Cap Financial fund has started to turn around. Ellison plans to buy more beaten-down names. "The opportunities are in the places that some people deem horrible," he says.

As we reach 2008's halfway point, the overall stock market isn't far from where it was last summer, despite all its ups and downs since then. But several sectors have all but collapsed over the past year, including investment banks, department stores and home builders. And that gives savvy investors a chance to scoop up bargains. Yes, the smart money is starting to pick up the pieces. Some companies are hurting, but they're priced as if they're going out of business. In other cases good companies have been unfairly punished. The U.S. economy looks shaky, with consumer spending sputtering and job losses climbing. But the stock market anticipates news and bakes it into stock prices, which is why it often turns around even while the economy is still reeling.

Some investors continue to avoid the worst of the worst. "Who needs to be a hero?" asks Steve Romick, who runs the FPA Crescent fund. Nevertheless, the valuations of some of the most beaten-up companies seem too low to overlook. To find the most promising midyear investments, we zeroed in on the sectors that were hit hardest over the past 12 months. We discounted those we deemed too far from a recovery (that means you, airlines and home builders). We then canvassed money managers and combed balance sheets, looking for the best combination of cheap valuations and solid businesses. The result: stocks whose better days should be ahead of them.

Even with the margin squeeze, Valero is bringing in plenty of cash. The company, which has 17 refineries, earned $193 million in the first quarter and bought back almost 9 million shares. On May 1 it raised its quarterly dividend 25 percent. Valero also is selling off some assets, which will give it more cash to buy back more shares and pay down debt. Analysts expect the firm to earn $3 billion, or about $5.50 a share this year, giving it a price/earnings multiple of about 8, a bargain for a profitable company going through what should be a temporary rough patch.

But while the Santa Clara, Calif.-based firm is expected to post lower profit this year than in 2007, analysts still expect it to earn $1.1 billion, or about 80 cents a share. What's more, the firm has very little debt and is sitting on almost $2 billion in cash. Over the past 20 years, microchip industry spending busts have lasted an average of less than 18 months, so if that pattern holds, a rebound could be near. Meanwhile, Applied has one set of customers that are spending like drunken sailors: solar-cell manufacturers. Applied Materials has figured out that its equipment and technology-which processes silicon into microchips-can be modified to process silicon into solar panels. Needham analyst Edwin Monk estimates that Applied Materials' solar business will grow from $250 million last year to more than $1 billion in 2008.

Indeed, bulls say IP's strong balance sheet gave the company the freedom to pounce when a good asset was up for grabs. With the credit crunch, "it was the only one who could put together a deal," says Citigroup analyst Chip Dillon. The acquisition fits with International Paper's plan to focus on paper and packaging. Since 2005 the company has sold other assets, including millions of acres of timberland. Consolidation in the packaging business also bodes well for IP's chances of raising prices to offset the surging cost of raw materials and energy, which chip away at profits. Dillon thinks International Paper could earn $4.90 a share in 2010 and that the stock could climb to $44. And while the company may not be in a position to raise its dividend, it's still giving shareholders a yield of 4 percent to wait it out.

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