3 Top Small-Cap Stocks to Buy and Hold in 2023

Today we’re looking at higher-quality small companies whose stock prices are appealing. Specifically, these companies all land in the small-cap tier of the Morningstar Style Box, they all earn wide economic moat ratings, and they all look undervalued according to our metrics.

3 Top Small-Cap Stocks to Buy and Hold in 2023

These 4- and 5-star stocks look undervalued. Data as of Feb. 2, 2023.

1. Guidewire Software GWRE

2. Polaris PII

3. Compass Minerals CMP

The first high-quality small-cap stock on our list is Guidewire Software GWRE. Guidewire is the leader in core software solutions for the property-casualty insurance market; the company covers 25% of direct written premiums and wins more deals per year than its largest competitors combined. Morningstar’s analyst sees a significant opportunity for Guidewire to migrate more of its customers to the cloud in coming years, and we view the company as the primary winner as the property-casualty insurance industry continues to modernize. Guidewire stock trades well below our fair value estimate of $95.

Next is Polaris PII. Polaris designs and manufactures off-road vehicles for recreational and utility purposes and on-road vehicles, including motorcycles. The company’s fourth-quarter sales were solid, with all segments delivering strong growth. Although the company faces macroeconomic headwinds in 2023, Morningstar thinks shares are attractive for long-term investors, given Polaris’ brands, innovative products, and lean manufacturing. We also think management has done an exemplary job of allocating capital. We think shares are worth $175, and they’ve traded as much as 40% below that in 2023.

And rounding out our list of high-quality small-cap stocks to consider is Compass Minerals CMP. Compass Minerals currently produces two primary products: salt and specialty potash fertilizer. While winter weather and farmer planting decisions are major demand drivers for its business, the company holds unique assets with geological advantages that are nearly impossible replicate, which gives Compass a maintainable cost advantage over the long term. Further, Compass is expanding its operation to produce lithium, and Morningstar forecasts lithium demand to growth over 6 times during this decade due to higher electric vehicle adoption. We think shares of Compass Minerals are worth $80, and they’re trading at a 40% discount to that today.

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Morningstar strategist Seth Goldstein and senior analysts Jaime Katz and Dan Romanoff provided the research behind this segment.