Investing After Disaster Strikes: Eyeing Japan Stocks

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Includes: BP, DFJ, DIA, IWM, SPY
by: Tim Ayles

Being very aware of not wanting to sound insensitive to the massive amount of suffering being experienced by Japan after the horrible calamity it's dealing with, I will attempt to bring analysis that is both beneficial to the investor and to the country.

To the investor by presenting an investment in Japanese companies that offer an extreme value when compared to most other countries, and to Japan by making investors aware of places to put their capital, which Japan needs, within the country's borders.

Today, the WisdonTree Japan SmallCap Fund (NYSEARCA:DFJ) is down nearly 10%. The investment seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Japan SmallCap Dividend index. Last year's yield came in at about 2%, while Seeking Alpha has it listed at 3.59%, which is a very good dividend yield for an ETF that holds many individual companies.

But a dividend is only as good as the companies that are paying them. Are Japanese Small-Cap stocks good values at these prices? It is hard to say at the moment as it is not known how each company in the ETF has been impacted by the disaster. It is usually during disasters though when prices of stocks become extremely cheap (think BP (NYSE:BP) at $26.75 during the gulf disaster). Before this disaster, though, the companies in this ETF were already very cheap.

First, the 329 companies in the fund, as per Yahoo Finance, show that collectively they are trading at about 71 cents on the dollar from a price/book value standpoint. That means if each of the 329 companies were to liquidate assets and pay off their debts, the remaining cash available for shareholders would have been a 41% gain overnight pre-crisis. I am sure that book value on some of these companies will drop for sure, but even if it dropped 29% collectively, the companies would be trading at book value.

Secondly, the companies as a group are trading at a sales to price of around .35. That means for every $1 of market cap the companies have, they around $2.85 of sales. Compare that to the Dow Jones (NYSEARCA:DIA) or S&P 500 (NYSEARCA:SPY) which trade at 1.37 and 1.33 price/sales, respectively. For each dollar of market cap in the U.S., domestic stocks have only about .75 cents of sales. That is quite a value gap. A better comparison would be U.S. Small-Cap stocks (NYSEARCA:IWM) which trade at a 1.07, meaning our own small companies have only .93 cents of sales for each dollar of market cap.

Lastly, and I think most importantly, the companies in the ETF trade at a price/cashflow ratio of 3.4. What this means is that for each dollar of market capitalization, the company generates .29 cents of cash flow. We do not know the collective capital expenditures, so we cannot generate a free cash flow yield, but this cash flow number is huge. That is roughly a 29% cash flow return for each dollar of investment for someone who buys DFJ. This compares to a 14.7% cash flow yield for the Russell 2000 and only a tad over 12% for the Dow and S&P 500. Bottom line is the small cap Japanese companies are generating over 100% more cash flow per investor dollar invested.

With the news being as bad as it is, opportunity from fearful investor selling is staring the long term, deep value investor in the face. It might be wise to wait for the true scope of the disaster to be made known before buying, but the current crisis has made very cheap companies that pay a nice dividend even cheaper. Investing in Japanese companies is also a very small way that we can help, by supporting the Japanese markets with fresh capital.

Disclosure: I am long DFJ.

Additional disclosure: Most of our clients are long DFJ with a 0.5% weighting.