3 Small Caps on Sale

Small-company stocks are more popular than a pumpkin spiced latte in fall. The Morningstar US Small Cap Index is up about 22.7% for the trailing 12-month period as of this writing. That's nearly 2.5 percentage points ahead of the large cap index during the same time frame.

Market watchers suggest that small companies are edging out larger names because they're less vulnerable to trade-war talk: As a group, smaller domestic companies are less reliant on exports than their larger-cap counterparts. Others, meanwhile, argue that smaller companies may benefit more from last year’s tax cuts--hence the attraction.

Given their fashionable status, we decided to look for smaller companies that our analysts cover trading in 4- and 5-star range, suggesting that they're undervalued. Seventeen stocks made the cut. Premium Members can access the full list

Here's a little bit about three diverse names from the list.

Imax

IMAX

Morningstar Rating (as of 8/31/18): 4 stars

Economic Moat: Narrow

Moat Trend: Stable

Market Capitalization (bil): $1.47

Unlike others featured here, shares of the media company are about flat this year--despite ongoing revenue growth. Today, Imax is largely a technology hardware and brand licensing company, explains analyst Neil Macker. It doesn't operate the vast majority of Imax theaters; instead, it generates revenue by selling and leasing the required equipment and by remastering standard films into the Imax format. Revenue is also tied to a percentage of box office for Imax films.

"We assign Imax a narrow economic moat based on its format standards and technologies, including its projection systems and digital film conversion process," says Macker. "The firm has leveraged these assets to become the dominant player within the premium large-format cinema marketplace, with over 50% market share."

Morningstar is modeling 6.5% average annual revenue growth over the next five years, and expects overall operating margins to expand to 25.6% in 2022 from 12.7% in 2017 as the firm gains leverage on selling, general, and administrative as well as research and development expenses, summarizes Macker. Shares currently trade about 22% below our $30 fair value estimate.

Synaptics

SYNA

Morningstar Rating (as of 8/31/18): 4 stars

Economic Moat: None

Moat Trend: Stable

Market Capitalization (bil): $1.71

Shares of the human interface solutions developer are up about 20% this year. The firm announced that it plans to restructure its optical fingerprint business for the mobile market. Management feels the optical fingerprint market wasn't highly differentiated and would therefore be prone to price erosion, explains senior analyst Abhinav Davuluri. Davuluri expects Synaptics to redouble its opportunities for advanced touch and control display controllers and consumer "Internet of Things" devices. It's becoming a more diversified semiconductor firm.

Morningstar thinks Synaptics will grow its top line at a compound annual growth rate of 4% during the next five years; longer term, the firm will take advantage of the proliferation of OLED displays in smartphones that will require more advanced touch and display driver chips. Given these trends, Morningstar assigns a $64 fair value estimate to the stock; shares are trading about 25% below that.

"We believe investors with the patience to deal with the volatile nature of the semiconductor component space may find current levels attractive," concludes Davuluri.

US Concrete

USCR

Morningstar Rating (as of 8/31/18): 4 stars

Economic Moat: None

Moat Trend: Stable

Market Capitalization (bil): $0.81

One of the smallest companies on our list, U.S. Concrete sells ready-mixed concrete in several major markets in the United States, including Texas, northern California, and the New York metro area. Shares are down more than 40% this year, a significantly larger loss than any other U.S.-focused building materials company. Much of the drubbing occurred after the company reported first-quarter earnings, notes analyst Kristoffer Inton.

"Though U.S. Concrete faced some weather-related headwinds during the first quarter, we saw little justification for its significant price decline in absolute terms or relative to its peers," argues Inton.

Based on our volume and pricing forecasts, Morningstar pegs the firm's fair value at $75 per share; shares are trading 36% below that.

"Driven by recovery in construction demand, we expect robust volume growth in U.S. Concrete’s ready-mixed concrete volume," explains Inton. "We forecast volume to reach more than 12 million cubic yards by 2022, compared with 9 million cubic yards in 2017. Amid this healthy demand growth, we expect U.S. Concrete to push roughly 3% average annual price increases through 2022."