2 More of the Best Small-Cap Stocks to Buy While They’re Still Undervalued

Key Concepts

• Small-Cap Stocks: Stocks with a relatively small market capitalization, generally considered to be between $300 million and $2 billion.
• Economic Moat: A company’s ability to maintain competitive advantages over its rivals in order to protect its long-term profits. Classified as narrow, wide, or none.
• Undervalued Stocks: Stocks trading at a price below their intrinsic value, as determined by analysts.
• Distilled Spirits: Alcoholic beverages produced by distilling grains, fruits, vegetables, or sugar.
• Intrinsic Value: An estimation of what an asset should be worth based on an analysis of its underlying fundamentals.

Small-Cap Stock Performance & Market Overview

Since November, small-cap stocks have demonstrated superior performance compared to large-cap stocks. This observation stems from analysis presented on the Morning Filter podcast, where Morningstar’s chief US market strategist, Dave Sakara, previously highlighted Mosaic, TX, and Sensetta Technologies as undervalued small-cap options. This discussion expands on that initial analysis, presenting two additional small-cap stock recommendations.

Lamb Weston: Frozen Potato Market Analysis

Lamb Weston, identified as North America’s largest frozen potato producer, specializing in supplying French fries to restaurants, is presented as a compelling investment opportunity. Despite its focused product line, the company is expected to benefit from robust long-term demand. Prior to the pandemic, the global frozen potato market experienced a growth rate of 5% annually. Analysts anticipate a resurgence in growth, driven by favorable market conditions.

Lamb Weston is assigned a “narrow economic moat” rating by Morningstar. This rating is based on two key factors: cost advantages – likely stemming from economies of scale in production and distribution – and intangible assets built through long-standing relationships with its customer base (restaurants). The company’s stock is currently valued at an estimated $80 per share.

Brown-Forman: Premium Spirits & Brand Strength

Brown-Forman, a manufacturer of premium distilled spirits, including the renowned Jack Daniels Tennessee whiskey, Woodford Reserve, and Old Forester bourbon brands, is the second recommended small-cap stock. The company possesses a “wide economic moat” attributed to the strength and recognition of its brands.

While recent financial results have been impacted by weakened demand in North America and Europe, the long-term outlook remains positive. Morningstar projects that Brown-Forman will achieve an average annual sales expansion of 3% over the next decade. This growth is anticipated to be fueled by brand strength, ongoing product innovation, and expansion into emerging markets. The current estimated value of Brown-Forman shares is $37 each.

Investment Strategy & Further Resources

The analysis emphasizes identifying undervalued stocks within the small-cap segment. The selection criteria focus on companies with demonstrable competitive advantages – represented by the economic moat rating – and potential for future growth.

Susan Jabinsky directs listeners to the Morning Filter podcast (available on all major podcast platforms) for additional stock ideas and to Morningstar’s website, morningstar.com, for further research and analysis.

Synthesis

The core takeaway is the potential for strong returns within the small-cap stock market, specifically through investments in companies like Lamb Weston and Brown-Forman. These companies are characterized by established market positions, strong brands, and identifiable competitive advantages (economic moats) that position them for long-term success despite current market headwinds. The analysis highlights the importance of considering both current challenges and future growth prospects when evaluating investment opportunities.