The stock market’s volatility continues. With many large S&P 500 firms posting weakened earnings and challenging outlooks for 2023, investors are approaching many of America’s corporate giants with extra caution. However, there are alternatives to investing in these behemoth companies.
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Oftentimes, companies that fly under the radar can avoid much of the broader market chaos. And, in particular, small-cap stocks tend to be more domestic in nature, which insulates them from the geopolitical shocks and foreign exchange swings that have tripped up many multinational companies lately. Besides these advantages, U.S. small-cap stocks have historically outperformed their larger peers by a significant margin over a long time horizon.
To both grow and thrive, however, a company needs a competitive advantage over its peers — what Morningstar calls its “moat.” A company with a wide moat is one Morningstar believes has “competitive advantages strong enough to fend off competition.”
With that in mind, here are five companies Morningstar views as having wide moats, making them some of the best small-cap stocks to buy for 2023 and beyond:
| Small-cap stock | Discount from fair value |
| John Wiley & Sons Inc. Class A (ticker: WLY) | 32% |
| The Western Union Co. (WU) | 36% |
| Compass Minerals International Inc. (CMP) | 50% |
| Core Laboratories Inc. (CLB) | 24% |
| Guidewire Software Inc. (GWRE) | 14% |
John Wiley & Sons Inc. Class A (WLY)
Commonly known as Wiley, you’ve likely encountered a John Wiley & Sons product or two in your school years. It’s one of the world’s leading educational material publishing companies, from journals to textbooks and even post-secondary course material and lifestyle books.
From humble beginnings as a New York City print shop more than 200 years ago, WLY has developed a considerable competitive advantage that Morningstar equity analyst Zain Akbari says will “endure despite near-term student enrollment-related volatility.”
He attributes this wide moat to Wiley’s journal unit of “must-have” titles and “deep relationships with academic institutions, researchers and corporations.” The cost for these customers to switch from Wiley products would be high, Akbari notes.
That said, Akbari adds that this competitive advantage may be deteriorating due to a shift away from educational textbooks, so keep an eye on this company if you plan to invest long term.
WLY gets five out of five stars from Morningstar and closed at $36.17 on May 30, a 32% discount to Morningstar’s fair market value of $53.
The Western Union Co. (WU)
The Western Union Co. makes moving money easier by providing money transfer services across the globe. It’s this digital channel that Morningstar senior equity Analyst Brett Horn sees as of particular importance to WU’s competitive advantage.
He notes that despite unimpressive first-quarter 2023 earnings, there are “signs the company is working through its recent issues and heading toward overall stabilization.” For this reason, he still considers it to have a wide moat based on its sizable scale advantage.
“Western Union is the clear leader in an industry where size confers significant advantages,” he writes. “The money transfer business is highly scalable because the incremental costs of processing additional transactions are minimal.”
This has given WU a “marked cost advantage” over competitors with operating margins that are about twice that of its competition. Despite this, Horn also notes that a “stagnant top line” could bring the value of that moat into question going forward.
WU gets five stars from Morningstar and closed at $11.56 on May 30, a 36% discount to its Morningstar fair market estimate of $18.
[See: 7 Top Equal-Weight ETFs to Buy]
Compass Minerals International Inc. (CMP)
As a producer of salt, plant nutrients and magnesium chloride, Compass Minerals has an “enviable portfolio of cost-advantaged assets,” according to Morningstar strategist Seth Goldstein. “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.”
The challenge for CMP is that its salt sales are largely based on the number of snow days per season, causing weather to play a big role in the company’s revenue. Relying on snowfall for sales also means CMP is exposed to climate change risk.
“One effect of climate change is increased snowfall volatility from year to year, which affects Compass’ annual results,” Goldstein writes. “However, winter weather has shown mean reversion tendencies over longer periods of time.”
Even in Morningstar’s downside scenario with lower salt volumes and profits alongside a “little recovery in plant nutrition volumes and profits,” Goldstein still gives CMP a fair market value of $30, which it is barely trading above $33.
“As such, we view the current price as an excellent opportunity for long-term investors to pick up Compass Minerals shares with a solid margin of safety,” Goldstein writes.
CMP gets five stars from Morningstar and closed at $32.50 on May 30, a 50% discount to its fair value estimate of $65.
Core Laboratories Inc. (CLB)
Things are looking up for Core Laboratories in 2023, according to Morningstar analyst Katherine Olexa. As a leading provider of reservoir characterization services, which is used when developing and managing reservoirs, CLB’s “foundational core analysis business has been virtually untouched over the last several decades,” she writes. It’s also been successful at expanding when customers want more without straying from its niche.
While COVID-19 took a bite out of its return on invested capital, or ROIC, Olexa is “confident” CLB will bounce back. She estimates ROICs will average 27% over the next decade, reaching 33% by 2032.
CLB gets four stars from Morningstar and closed at $22.12 on May 30, a 24% discount from its fair value estimate of $29.
Guidewire Software Inc. (GWRE)
“Guidewire is coming to dominate a sleepy niche,” writes Morningstar Senior Equity Analyst Dan Romanoff. As a software provider for property and casualty, or P&C, insurers, he believes “Guidewire is reaping the benefits of years of groundwork” by convincing P&C insurers to “upgrade their aging core legacy systems to Guidewire’s solutions.”
He sees this industry as “sleepy” because it has long been dominated by legacy software vendors. Given this, he says there is still a long runway for GWRE and that the company has already earned a wide moat due to the higher switching costs for software. In other words: Once you go Guidewire, you’re unlikely to go back.
With a market cap of around $6.5 billion, GWRE doesn’t meet everyone’s definition of small-cap, which often tops out at $2 billion, but Morningstar considers any company in the bottom 10% of the capitalization of U.S. equities to be small-cap stocks. GWRE fits this definition.
GWRE gets four stars from Morningstar and closed at $81.60 on May 30, about a 14% discount to its fair value of $95.
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5 Best Small-Cap Stocks to Buy in 2023 originally appeared on usnews.com
Update 05/31/23: This story was published at an earlier date and has been updated with new information.
