Are Japanese Equities Being Unfairly Discounted?

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At the 2012 Invest for Kids conference David Herro of Harris Associates gave his thoughts on why investors should be looking at equities right now, and specifically those equities in Japan. Herro states that it is “not always the best idea to judge particular stocks based on the country they are located in.” Herro’s firm, Harris Associates, is a Chicago-based investment company managing some $70 billion of assets. Herro acts as the CIO of Harris and was named Morningstar’s international stock Fund Manager of the Decade for 2000-2009.

Herro notes there is fear all around the world, which includes a “slowdown in China, EU concerns and a Japanese economy that has been stagnant for over ten years." Herro’s investment thesis is to look at equities amidst all this fear, where there are some good buying opportunities. Most notably, Herro recommends looking at Japanese equities and points out that valuation levels have plummeted globally, and are now down over half from 2007 levels.

Getting back to the fund manager's main point, Herro notes that investors should not judge Japanese stocks based on Japan’s economy. Herro reiterates that cheap countries and cheap economies make for good stock finds. We have identified five of Japan’s top stocks, including Toyota Motor (NYSE: TM), Honda Motor Co (NYSE: HMC), Sony (NYSE: SNE), Canon (NYSE: CAJ), and Mitsubishi (NYSE: MTU). The Japanese market’s P/E is around 22x, and three of these companies are trading cheaply to the market, one trading rich, and the other with no measurable P/E.

Toyota and Honda, the two automakers, trade well below the market average P/E, both trading at 13x earnings. These two companies also pay a dividend of at least 2%, and both also have robust growth prospects—each is expected to grow EPS over the next five years at close to 30% annually. There will be some near-term pressure that might provide for even better buying opportunities as each automaker faces a territorial dispute between Japan and China. Honda has more exposure to North America, and so this automaker will perform better should a U.S. auto industry recovery take hold. Check out billionaire T. Boone Pickens’ thoughts on the auto industry.

Sony currently has an incalculable P/E given its most recent string of negative earnings. This electronics company is feeling the pressure from China, as the Chinese boycott Japanese products. They are also seeing pressure from a declining TV industry. Sony, on the back of a solid product mix, is expected to see revenues up 5% in 2013, but remains down over 40% year to date as a significant decline in LCD TV sales is expected to continue.

Canon trades the cheapest of the five companies on a P/E basis at only 12x earnings and also pays the highest dividend at a 4.8% yield. Slowing demand for printers and cameras are mitigating revenue growth, with expected sales down 1% this year from last. Trading near a three year low, the company’s strong market position will help it grow sales at least 4% next year, and management has made a commitment to continue to return capital to shareholders. Canon also saw some of the more robust action from hedge funds, as there were notable managers taking new stakes or upping their 1Q positions, including Israel Englander, Ken Griffin and Steven Cohen. Check out all the funds that love Canon.

Mitsubishi, the banking business, trades the highest on a P/E basis at 61x earnings. The banking company has made various acquisitions of late, but earnings are still expected to come in flat over the next five years. On a trailing P/E basis, Mitsubishi is well above its banking peer average P/E of around 20x, but the financial company’s 8x forward earnings puts it much more in line.

We believe the two auto companies are interesting investments as they continue to strengthen production following the Japanese earthquake and are expected to grow robustly in the near future. We remain cautious on Sony as not only its TV segment continues to wither, but its PC and laptop segments are also seeing pressure from tablets. We like Canon’s high dividend and solid geographical diversification, but would be cautious on the banking business Mitsubishi given low opportunities for growth.


This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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