Contrarian Appleseed Fund Picks 4 Japanese Stocks on Eve of Earthquake Anniversary

Earthquake, government debt–even the Yakuza–are not a bar to shareholder-friendly companies, says Josh Strauss

Japan has seen no end of troubles in the last year as natural disasters and stagnant growth have weighed on the Nikkei stock index, which finished out 2011 at its lowest level since 1982. Even bottom feeders have had a hard time finding a reason to buy Japanese equities.

But some contrarian investors like portfolio manager Josh Strauss (left) of the Appleseed Fund are waking up to the fact that “the cheapest stock market in the world that everybody hates,” as Strauss calls Japan, is presenting some great buying opportunities.

“Historically, the investment case for avoiding the Japanese market has merit, but these negatives are well priced into the Japanese stock market and then some, in our opinion,” Strauss told AdvisorOne on Monday. “We own some Japanese companies that are trading below the cash on their balance sheet.”

The negatives of the Japan story are clear, Strauss conceded: last year’s earthquake and tsunami, stagnant growth, demographic pressures from an aging population, and the Japanese tendency to under-invest in stocks while overinvesting in savings accounts earning close to 0%.

Appleseed has a 100% hedge on its yen position through the futures markets, so it is long Japanese stocks but short the currency. The yen is at a nine-month low against the dollar, which is supporting Japanese exporters.

As for the notorious Yakuza, the Japanese criminal group whose godfather was banned last Thursday by the Treasury from entering U.S. markets, Strauss said the group doesn’t impact his investments.

“It’s not part of our stock selection process. I don’t even think about it,” he said. “I would be as fearful about the Yakuza infiltrating Japanese business as I would the Mafia infiltrating U.S. business.”

Even before the earthquake, Japanese stocks were in a two-decade bear market and trading at compelling valuations, Strauss noted last year in the Chicago-based Appleseed-Fund’s semi-annual report. For example, he wrote, the benchmark Nikkei index of the Tokyo Stock Exchange was trading at an attractive price to book value of 1.0x.

“The Japanese economy, which was not especially strong prior to this sequence of unfortunate events, has since weakened significantly and undoubtedly is in recession,” Strauss wrote. “The good news is that the Japanese people are extremely resilient and resourceful, having demonstrated time and again that they can bear the unbearable.”

For contrarians, that means some intriguing investment opportunities. Strauss includes the following four Japanese companies in his portfolio of stocks for the Appleseed Fund. These four stocks comprise roughly 13% of the portfolio:

  1. Shimano (7309-JP)–“Think of them as the Intel of bicycle component companies,” Strauss said. “They dominate their market share of bicycles that cost more than $150.” The vast majority, 88%, of sales is outside Japan. Positive investment characteristics include a recognized brand, strong balance sheet, top-notch engineering squad and no earthquake exposure.
  2. Mabuchi Motor (6592-JP)–This company manufactures small DC motors used in products such as digital cameras. Free cash flow positive for the last 10 years, Mabuchi has a 50% market share globally and a current 2.7% dividend yield.
  3. Rohm (6593-JP)–With a moderately attractive growth profile, Rohm is a diversified semiconductor producer. The company got hurt by the earthquake and flooding, yet the stock trades at 0.7 to book. “It’s very cheap,” Strauss said.
  4. Dr. Ci: Labo (4924-JP)–A high-end skin care manufacturer, Dr. Ci: Labo is an “extremely” profitable and growing medical skin care company whose founder and owner is a dermatologist, according to Strauss. The domestically oriented company has ROE of 20%.
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