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Japanese stocks have been cheap for over 20 years, and for about the same amount of time, value investors have been interested in these stocks. Though they trade at price-to-book multiples that are below their U.S. counterparts, they also face special challenges that should give U.S. investors pause.

Discounts to Book Value

There are many Japanese stocks whose price-to-book ratios are lower than the 2.03 average of the S&P 500:

Ticker

Company

Industry

P/E

P/S

P/B

(NYSE:SNE)

Sony

Electronic Equipment

NA

0.13

0.45

(NYSE:NTT)

Nippon Telegraph &Telephone

Telecom Services -Foreign

9.71

0.46

0.55

(NYSE:NMR)

Nomura Holdings

Investment Brokerage- National

30.21

0.68

0.61

(NYSE:MTU)

Mitsubishi UFJ Financial

Money Center Banks

113.75

2.03

0.64

(NYSE:IX)

ORIX

Credit Services

13.3

0.98

0.66

(NYSE:MFG)

Mizuho Financial

Foreign Regional Banks

4.95

2.22

0.71

(NYSE:SMFG)

Sumitomo Mitsui Financial

Foreign Regional Banks

8.63

2.33

0.72

(PC)

Panasonic

Electronic Equipment

NA

0.15

0.9

(OTCPK:MITSY)

Mitsui

Conglomerates

6.38

0.47

0.93

(NYSE:KYO)

Kyocera

Diversified Electronics

24.13

1.22

0.94

(NYSE:DCM)

NTT DOCOMO

Telecom Services -Foreign

11.02

1.21

0.95

(NYSE:TM)

Toyota Motor

Auto Manufacturers -Major

15.09

0.57

1.06

(NYSE:HMC)

Honda Motor

Auto Manufacturers -Major

14.99

0.55

1.13

(NYSE:KNM)

Konami

Multimedia & Graphics Software

15.71

1.21

1.34

(OTCPK:NSANY)

Nissan Motor

Auto Manufacturers -Major

NA

NA

1.34

(NYSE:CAJ)

Canon

Photographic Equipment & Supplies

16.37

1.19

1.48

(OTCPK:MKTAY)

Makita

Small Tools &Accessories

15.12

1.65

1.5

(KUB)

Kubota

Diversified Machinery

18.43

1.11

1.68

(NYSE:NJ)

Nidec

Industrial Electrical Equipment

13.5

1.06

1.88

Though many of these investments are household names, there are some big reasons to think twice about these names. First, Japan's currency is expensive relative to the dollar, making these stocks less of a bargain. Secondly, Japan's population is declining and its population is getting older. This hinders growth.

International Buyers and Partners

If there is a price discrepancy, there is an opportunity for arbitrage. In the context of cheap Japanese equities, this means that foreign companies can purchase assets and ownership of Japanese companies on the cheap and then use these acquisitions elsewhere. Knowing this, investors should keep an eye out for cheap Japanese firms which would make good acquisitions for other companies.

Qualcomm's Partnership

Qualcomm (QCOM) recently announced plans to acquire a stake in Sharp, a Japan-based TV maker and plans to partner with a U.S. company to make displays. The agreement involves a sale of $61 million of new shares to Qualcomm. It acquired a 2.6% stake in Sharp. They will jointly develop liquid crystal displays based on the Indium Gallium Zinc Oxide technology, which is more energy efficient.

According to Derek Aberle, Group President and Executive Vice President at Qualcomm:

Expanding our existing relationship with Sharp to jointly commercialize new MEMS display technologies will help both companies realize their shared goal of driving high performance, lower power displays for a variety of devices, including smartphones and tablets.

Sharp is a manufacturer of liquid-crystal displays and reported $1.23 billion in cash from operations during the first half of the fiscal year due to dwindling demand and facing stiff competition from Samsung Electronics. It also failed to win a planned investment from Taiwan's Foxconn Technology Group. In such a situation, this investment in the firm would be good news for it. But it won't improve the company's situation drastically. During the year, Sharp's stock declined 74%, making it the world's second worst performing stock.

Due to fall in demand of displays Sharp forecasted a loss of $5.39 billion during the year which created a 'material doubt' about the company's ability to survive. Earlier, the company entered into an agreement to dispose of its $800 million stake in itself to Foxconn Technology Group. A decline in the company's share price led to renegotiations in the terms of the agreement and it believes that the talks may continue till March. According to the Wall Street Journal, the company is also in talks with Dell (DELL) to get an investment worth $240 million. Kyodo News said that the company is in talks with Intel (INTC) to receive an investment worth $480 million. According to Takashi Okuda, the President of Sharp, the company is looking at various partnership options. According to Asahi newspaper, the Company is planning to enter into partnership with Hewlett-Packard (HPQ), Intel, Microsoft (MSFT), Google (GOOG) and Apple (NASDAQ:AAPL).

Qualcomm plans to invest an additional $598 million in Sharp if the partnership tends to be fruitful.

Japan's Financial Institutions

Financial institutions may exacerbate price declines as they may be required to sell holdings in tough times.

The combined losses of the three biggest companies in Japan, Sumitomo, Mitsubishi, and Mizuho more than tripled compared to the figures from the same period last year. Mizuho is making efforts to reduce their shares in other companies in an effort to reduce their lender's shareholdings. Koji Haji, a researcher, said:

Mega banks should carefully and gradually cut their shareholdings to mitigate fluctuation risks and further stabilize their management," he added that "If they rush to sell them off, they'd see an adverse impact on Japan's economy as a whole and further weaken lending demand.

There seems to be some hope that the situation may get better as companies such as Nikkei and Mitsubishi reported an increase in their share prices this month. Companies such as Mitsubishi have taken efforts to reduce their stakes in other companies and there are plans underway for further reduction to this amount.

Institutional selling is a very real threat. The stock holdings of most banks in the country dropped to the lowest level since 1997.

Conclusion

Shrewd investing in Japanese stocks requires more than seeking a low P/B ratio. Instead, you should focus your research on companies that are geared toward becoming international acquirers and partners.

Source: Use Caution When Buying Japanese Stocks