Small-capitalization stocks have outperformed large-cap over the past year, after underperforming for more than six years prior to that.
The Russell 2000 index of small stocks eked out a gain of 0.21% during the past 12 months, compared with a 6% decline for the S&P 500.
So now might be a time to consider small-cap stocks for portfolios. Here are three top small-cap stocks cited by Morningstar. They all earned wide-moat (durable-competitive-advantage) designations from Morningstar analysts. And they all trade well below the analysts’ fair-value estimates.
Guidewire Software (GWRE), a provider of software solutions for the property-casualty insurance market, according to Morningstar analyst Dan Romanoff. He puts fair value for the stock at $95, 25% above recent trades at $76.
“The company already covers 25% of direct written premiums, and it wins more deals per year than its largest competitors combined,” he wrote in a commentary.
“We continue to see Guidewire as the primary winner as the P&C insurance industry continues to modernize. And we see consistent momentum in Tier 1 insurers selecting the platform.”
Further, “just as the company nudged the industry to modernize, we believe it will be at the forefront now as it leads a wide array of the largest insurers into the software-as-a-service age with cloud-based solutions,” Romanoff said.
Polaris (PII), the maker of recreational and utility vehicles. Morningstar analyst Jaime Katz puts fair value for the stock at $175. It recently traded at $116.60, 50% below the analyst's fair-value estimate.
“Polaris is one of the longest-operating brands in powersports,” she wrote in a commentary. Its wide moat stems from “its brands, innovative products, and lean manufacturing yield,” she said.
“It stands to capitalize on its research and development, solid quality, operational excellence, and acquisition strategy.”
A caveat: “Polaris' brands do not benefit from switching costs,” Katz said. “Peers are innovating more quickly than in the past, which could jeopardize the firm's ability to take price and share consistently, particularly in periods of inflated recalls or aggressive industry discounting.”
Still, “as constraints in the supply chain continue to ease, 2023 should see improvement in [Polaris’] market share,” she said.
Compass Minerals (CMP), a producer of salt and specialty potash fertilizer. Morningstar analyst Seth Goldstein puts fair value for the stock at $80, 75% above recent trades at $45.70.
“Compass Minerals holds an enviable portfolio of cost-advantaged assets,” he wrote in a commentary.
“Its Goderich rock salt mine in Ontario benefits from unique geology, and with access to a deep-water port, it can deliver deicing salt to customers at a lower cost than competitors.”
As for fertilizer, “the company controls one of only three naturally occurring brine sources that produces the specialty fertilizer sulfate of potash,” Goldstein said.
“These operations at the Great Salt Lake in Utah can produce [sulfate of potash] at a lower cost than marginal cost producers who convert standard potash.” Compass also plans to produce lithium, which is used in electric-car batteries.
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