Japanese stocks for long-term investors:Seven stocks to watch in 2016

Seven stocks that brighten the Japanese equity investment picture

    Companies that forecast real recurring profit growth of 10% or more in FY16 amount to only 17% of TSE-1 stocks. That figure is likely to become even smaller after the conclusion of the FY15 results season. As we head into an earnings downtrend, the need to focus investment on the dwindling group of stocks with solid earnings prospects is more important than usual. In this report, we present the results of stock screenings based on three factors: (1) robust earnings, (2) outlook for growth in medium-term net profits (ie, profits attributable to parent company shareholders), and (3) risk-adjusted ROE. We have found seven stocks that appear attractive over the long term from all three factor perspectives: Kakaku.com, M3, Nisshin Steel, Disco, Mitsui OSK Lines, Secom, and Misumi Group.

    First, to find stocks with robust earnings, we turned to our sector analysts for a list of stocks expected to generate strong earnings growth over the next five years. This group can be divided into three subgroups: strong growth stocks (60%), stable earnings stocks (10%), and rebounding earnings stocks (30%). If we expand our universe a bit, the list of stocks likely to sustain high profit growth rates includes a rather large number of small caps. Our analysis has revealed six sector groupings that we consider to be Japan’s growth subsectors: (1) manufacturing (specifically, electronics and autos), (2) healthcare, (3) consumer spending-related stocks, (4) services sector stocks (specifically, services for individuals as well as staff recruitment and other business services), (5) software & IT services (especially payment settlement and sales support), and (6) financials/real estate. Medium-term net profit growth is another important factor in long-term investment decisions. Stocks for which it is possible to indicate a medium-term net profit outlook have merit by that very virtue alone, in our view. Indeed, analysts’ ability to draw up forecasts for medium-term net profit growth will probably become more important now that the Financial Services Agency (FSA) has called a halt to the practice of companies giving earnings previews to securities companies prior to the announcement of actual results. Risk-adjusted ROE is a key tool for assessing the quality of a company’s ROE. Companies with the same ROE can display different degrees of ROE volatility. From the perspective of ROE quality, we would view the stock with low ROE volatility more favorably than the one with high ROE volatility. Indeed, valuation discounts assigned to Japanese equities are due not only to low profitability but also to high earnings volatility. Being able to determine when earnings deterioration will end is almost as important as an accurate reading of how much earnings will eventually improve. We conducted the screenings presented in this report with the aim of creating a universe of Japanese stocks for long-term investors. We hope the results will be useful to our readers. Owing to the timing factor, we have probably left some room for a more precise quantitative analysis. The results presented here may therefore still have some rough spots. If possible, we would like to take up the subject of a universe of Japanese stocks for long-term investors again after the FY15 results season.