By Scott Ronalds

At our recent client presentations, there was a subtle shuffling of feet and an air of unease when the topic of Japan came up. Japanese stocks have been an area of increasing interest for our global manager (Edinburgh Partners) and we laid out the reasons why:

• Japanese stocks are cheap on several measures.
  
• The proverbial story of an overvalued stock market and stagnant economy is outdated. Despite an ugly aggregate picture, there are key areas of strength and businesses worth owning.
  
• The future for China lies in increased consumption and Japan holds strong market leadership in consumer electronics and manufacturing/automation.

Yet, investors still love to hate Japan. The country’s stock market has trended downward for two decades, its economy has sputtered and its demographics are unfavourable (the population is the oldest in the developed world). The warts are easy to see, which is why most investors prefer to ignore the region.

Lately, however, Japanese equities are raising some eyebrows. As mentioned, Edinburgh Partners likes the prospects of select stocks and feels there is cause for optimism. The firm’s CEO, Sandy Nairn, has scripted a précis on why he believes the market is worthy of investment. You can download the summary here (a warning, though – it’s 19 pages long and quite technical).

Warren Buffett plans to visit the country soon and noted last spring that he’d like his company (Berkshire Hathaway) to make a big acquisition in Japan in coming years. His sidekick, Charlie Munger, noted that Berkshire is “quite favorably disposed to doing more in Japan.”

The New York Times also recently published an article titled Japanese Stock Market is Getting New Respect which suggested that fire-sale stock prices are slowly attracting more investors. The piece quotes a New-York based manager: “Japan is by far one of the cheapest markets in the world … it’s so universally hated, yet it might be one of the world’s best-performing markets over the next five years.” The article cites some interesting facts:

• Nearly two-thirds of the 1,700 companies listed on the Tokyo exchange have price-to-book ratios below 1 (meaning if one of those companies was dismantled and sold off for parts, it would fetch more than its market value).
  
• Despite a recent up-tick, the market is still more than two-thirds off its 1990 peak.
  
• Some companies are starting to raise dividends and have announced share buybacks to counter longstanding investor complaints that companies hoard too much cash.

Further, the author suggests that Japanese export-oriented companies seem like a less risky way to invest indirectly in the Chinese growth story, and if the inflation emerging in other countries spills into Japan, it could help reverse depressed prices, which would be positive for the market.

The Japanese market has been down-and-out for 20 years – enough to discourage many investors. But stocks are cheap and the country is well-positioned to benefit from increased consumption throughout Asia. Our global manager sees Japan as fertile ground for value. It appears that the country is slowly starting to get a little love from other managers too. We recognize that the Japanese story is an uneasy one for some investors, but we strive to be transparent in our communications. Our discussions on unloved investments may lead to more feet shuffling and unease at future client presentations. Thus, we’re thinking of serving wine beforehand – which may tie in nicely with our conversation on France.