The Most Undervalued Stocks in the World

Ryan Fuhrmann's picture

Wednesday, January 26, 2011 - 7:00am

by Ryan Fuhrmann

If you think the "lost decade" of stock returns seen in the United States since 2000 is bad, you probably haven't been paying attention to Japan.
Japan's stock market officially peaked on December 29, 1989, and has yet to recover more than 20 years later. But many companies in the country have continued to do well despite the suffering of the overall stock market. Japanese stocks used to be expensive, with the average stock trading for a price-to-earnings (P/E) ratio of nearly 50 at the market peak in 1989, and an eye-popping 70 as the bursting of the bubble hit earnings in the mid-1990s. Valuations have declined since, and are now trading for an average P/E of 15.6.

Japanese stocks have fallen to levels only seen a couple of times since its market peaked. The market fell to more reasonable levels earlier this decade and perked up during the apex of the financial crisis on optimism that Japan was "decoupling" with the United States. But the Japanese market has again fallen back to earth. This makes Japan one of the most appealing stock markets in the world.

A key reason for this appeal is Japan's economy is geared toward exporting. Unfortunately, the strong yen has hurt sales by making Japanese goods and services more expensive to foreign markets. However, this is just a near-term blip and a number of Japanese firms that are global leaders are likely to continue growing robustly over the long haul. Going forward, the yen should come back down and make Japanese exports more competitive. Over the long run, currency fluctuations tend to cancel out, and Japan will stand out for supplying a growing world economy with automobiles, industrial components, apparel, and related goods and services.

Here are five appealing ways to gain exposure to Japan right now.

1. Toyota Motor Corp. (NYSE: TM)
Business: Auto manufacturing
Current P/E: 19.5

Toyota is well known to U.S.-based investors. The most recent global recession hit car sales badly and the company also got itself mixed up in a high-profile recall of thousands of cars over allegations of sticking accelerators, which damaged its reputation as a top-quality manufacturer. As a result, sales were hit rather significantly and earnings have cratered, but both are in recovery mode, making Toyota a definite rebound play.

Sales for 2011 are projected to rise more than 15% and reach more than $236 billion. Earnings could hit more than $4 a share in a year or two. To indicate the earnings recovery potential, note that earnings reached nearly $13 a share back in 2007, before the economy and product quality issues torpedoed the bottom line.

2. Fast Retailing (OTC: FRCOY)
Business: Retail
Current P/E: 21

Fast Retailing is an undisputed growth company that is blanketing the world with its popular UNIQLO clothing stores. It operates a number of other retail concepts -- including the Cabin brand in Japan and the Theory brand in both Japan and the United States -- and competes on a global scale with stores throughout the United States, Europe and Asia. The company has ambitious plans to open more than 1,000 stores in China in the next decade and plans to grow into one of the largest apparel retailers on the planet. Fast Retailing has a reputation for selling fashionable clothing at very low prices and therefore appeals to a vast market of cost-conscious consumers.

Financial details are a bit more difficult to find, given the company only issues financial statements in Japan. Sales have grown more than 16% in each of the past five years and profits are up almost 13% annually during this period. Returns on equity are very high and hit nearly 23% in 2010. At a P/E of close to 21, the valuation may not fit the profile of bargain stock, but given the growth profile, rising earnings should easily offset the fact that the multiple is above-average. In other words, a couple of years of rapid earnings growth will lower the P/E, and the stock will follow fundamental improvements over the long haul. Fast Retailing could be worth paying up for given its robust growth outlook.

3. Nippon Telegraph and Telephone Corp. (NYSE: NTT)
Business: Telecom
P/E : 10

NTT is Japan's dominant phone company and controls about half of the Japanese market. Given the firm's fixed-line focus, sales growth has been modest in recent years, but profits have grown steadily at more than 7% each year in the past decade. Weak core growth has been easily supplemented by its 57% stake in NTT DoCoMo, NTT's wireless subsidiary.

In other words, investing in NTT is similar to investing in AT&T (NYSE: T) or Verizon (NYSE: VZ) stateside. The firm's stated dividend yield is a bit more modest at just over 3%, but the P/E ratio is very modest at less than 10, which means the company doesn't have to grow much to earn returns for shareholders. Earnings are likely to continue to improve because of cost-cutting measures and growth at DoCoMo. In addition, there is downside protection, given the firm dominates its market. 

4. NTT DoCoMo Inc. (NYSE: DCM)
Business: Telecom
P/E ratio: 12

Investors with more of a growth bias may just prefer holding shares of NTT DoCoMo instead of its stodgier parent. DoCoMo also controls about half of the Japanese wireless market. It was the first company in the world to roll out a 3G network, but has since fallen behind by failing to introduce a 4G network fast enough. It appears to be getting its mojo back with the launch of the next generation of wireless technology. Profits are already high, and a return to sales growth could bring life back into the stock. The P/E ratio is quite reasonable at less than 12, and the stated dividend yield of 3.5% is also above average.

5. A general bet on Japan Inc.

Rather than ferreting out individual stock opportunities, investors may prefer to bet on Japan overall, given it has many large firms that successfully compete on a global scale. The MSCI Japan Index Fund (NYSE: EWJ) exchange-traded fund (ETF) is among the best passive approaches, as it provides a low fee way to gain exposure to Japan's leading companies. Toyota is the top holding, along with a few financial players among the top 10.

Fidelity offers a number of actively-managed options, including Fidelity Japan (Nasdaq: FJPNX) and Fidelity Japan Smaller Cos. (Nasdaq: FJSCX). Both have performed firmly ahead of their benchmarks during the past five years.
Action to Take ---> When investing internationally, it generally pays to go with the largest players that operate on a global scale. In terms of Japanese stocks in particular, there are plenty of options and the country has appeal given the stock market is offering some of the most attractive valuations of the past 20 years. If allowed only one choice, my money would be on Toyota, because it has a couple of key ways to boost earnings and will continue to grow briskly in the largest markets in the world.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.