Japanese stocks are cheap! They have been that way for nearly three decades. This leads to a few problems and makes it tricky when you decide to invest in them. So, how do you decide which cheap Japanese stock will provide a decent return on investment?
I’ve outlined ten tips and strategies that I use to pick out the best individual Japanese stocks. These tips should give you a general understanding of what to look for and hopefully lead you away from perennial underperformers.
1. Target Below Average Dividend Payout Ratios
From my nearly 5 years of investing in Japanese stocks I noticed something a bit strange.
Nearly all profitable dividend stocks I looked at had a 30% payout ratio.
This was odd and after reading through many different company financial reports it became apparent that it was by intention.
In one such report of a dividend increase, management decided to bring their dividend in line with their current profits, and target a 30% payout ratio. It was far from the first financial report I had seen state this. It’s likely many company’s if not most of them target this payout ratio.
This provides an opportunity for savvy investors to target stocks with rising earnings and payout ratio’s that are below 30%. Inversely avoid dividend stocks with payout ratios over 30% as the dividend may be reduced.
2. Buy Low Price to Asset Stocks
With so many Japanese stocks below book value it makes sense to target these stocks for an added margin of safety. Will free cash flow and revenues may be the only way to value American stocks, asset prices are king in Japan.
Japanese stocks also carry a lot of cash on their balance sheets which makes it easy to find stocks that trade below net current asset value.
3. Find Stocks with More Dividend Payouts Per Year
It’s very common in the United States for dividends to be paid out quarterly. It can be a bit of a shock in Japan to find out that a lot of companies only pay one dividend per year.
This can result in a stock having a dividend bump at specific times of the year resulting in weird bounces in stock prices. It also makes it more difficult to have a steady stream of income.
Targeting Japanese stocks that payout twice per year avoids weird stock fluctuations and spreads income throughout the year.
4. Find Strong Price to Earnings Growth
Price to earnings growth or PEG is one of Warren Buffets and many other value investors favorite valuation metric. It’s easy to see why, if a company is growing earnings every year then it is consistently more valuable into the future.
By adding price to the earnings story you can value a stock more strategically. With slow moving Japanese stocks its important to target low PEG because otherwise you are paying too much for slow growth.
It’s also important to add dividends to the mix. When doing this simply add the dividend yield to the earnings growth.
5. Invest in Japanese Stocks Directly
Many websites and Banks will ask you to invest internationally through index funds, mutual funds or ADRs. This is a mistake when investing in Japan.
Most funds and ADRs don’t offer the most profitable and cheapest stocks. They remain hidden on Japanese stock markets. This is because they are too tiny for large funds to buy and too unprofitable for banks to offer ADRs.
Through direct investing you can small overlooked stocks that are profitable, pay a dividend and have relatively low levels of debt.
It’s still difficult to buy Japanese stocks directly and one of the few and best places I know of is Interactive Brokers.
6. Find Companies Investing In Digital Technology
Japan is lagging when it comes to investing in office related technology that increases productivity. A lot of the government and older manufacturing centers still rely on fax machines for much of their communication.
Finding companies that are revamping their web presence and investing in technology that increases office work production are clear winners.
It may also be beneficial to invest in companies that have management younger than 60 years old. These companies will be more receptive to new ideas that can increase growth and reward shareholders.
7. Find Extra Low PE Ratio Stocks
It may be a bit strange and almost too good to be true when you come across a stock that has a PE of 3. But I assure you its ok, this is normal. At least in normal times.
With ultra low interest rates we have become accustomed to double digit PE ratios, and with the growth to support them its perfectly acceptable.
The problem with Japan is growth rates are not in the double digits so finding ultra low PE ratios with decent growth is a winning combination.
8. Target High Dividend Yields
Targeting high dividends is a strategy in and of itself. Many dividend investors use this strategy regularly. In Japan its best utilized with a value investors mindset.
If the dividend yield is high say above 4% and the payout ratio is below 30% like I mentioned earlier in the article, you may have an undervalued stock on your hands.
Its important to research the stock further to see if there are no special windfalls or unsustainable earnings bumps. But, if all of this reveals no red flags then it may be your next Japanese stock investment. This is not uncommon to find in Japanese stocks, but unlikely in other developed markets.
9. Invest in Newly Profitable Stocks
One of my best investments was noticing when a previously unprofitable stock became sustainably profitable.
After noticing two quarters of positive returns and a bit of due diligence I made my investment. Shortly after the stock doubled in price.
This tends to happen a lot in Japan since many don’t pay attention to all the small unprofitable stocks. At least until they hit the screeners over a year later.
10. Find Smaller Stocks Fund Managers Can’t Buy
Just like in the United States. There are stocks in Japan that larger investors cannot buy. If they were to even try they would buy the entire company before it would event make a dent in the returns of the ETF or fund.
By finding small Japanese stocks, typically a Market cap of less than $200,000,000 or 25,000,000,000 Yen we ensure we have less competition from the professionals.
As a result we can get better returns on our dividends and potentially get that added boost when the company grows to a level that funds can invest in them.