TRADE ALERT: On November 18, 2019 I alerted my readers that I sold my entire position in Tokyo Electron for a 39% gain in four months. Read more here. Follow me on twitter @OwlWealthy to get my trade alerts as they are published.
I recently set out to look for value and found it on the other side of the world, the Tokyo Stock Exchange.
What intrigued me about the Japanese market is that it essentially has been stagnant for the last three decades, potentially leaving some Japanese companies unfairly penalized. Consequently, there could be some under valued publicly traded Japanese companies that don’t deserve to be, and are only discounted because of the overall poor sentiment towards the Japanese economy. In other words, the tide had gone out on the Japanese economy, sinking all boats in its wake. The opposite of the “A rising tide lifts all boats” theory.
What has caused the tide to go out on the Japanese economy?
An aging workforce, restrictive immigration policies constraining the labor market, and high levels of public debt. While there are signs that the Japanese economy is heading in the right direction, I was still cautious.
I wanted to find undervalued, publicly traded Japanese companies that were protected from Japan’s poor demographics, have been growing earnings, and had limited debt risk. I decided to screen a bunch of Japanese publicly traded companies based on these three criteria:
Percentage of revenue derived from markets outside Japan greater than 75%
Earnings Per Share (EPS) annualized growth rate (over five-year period) greater than 5%
Debt to equity of 0.3 or lower
There are a lot of publicly traded Japanese companies on the Tokyo Stock Exchange - 2,292 to be exact. I didn’t want to deal with the complexity, fees and risk of foreign exchange so I decided to narrow my search to Japanese companies traded on the over-the-counter market (OTC).
I zeroed in on 16 publicly traded companies available on the OTC – notice how many car manufacturers make the list:
Canon
Sony
Bridgestone
Mazda
Nissan
Subaru
Toyota
Nippon Telegraph
Suzuki
Casio
Nikkon
Sharp
Fujitsu
Honda
Tokyo Electron
Sumitoro Company
Using my three criterion, majority of revenue coming from outside Japan, growing EPS, and low debt; I was able to quickly whittle my list down to three companies:
Sony (NYSE:SNE) - Sony designs and manufactures electronic equipment, instruments and devices for consumer, professional and industrial markets, and they produce and distribute music, motion pictures and television.
Tokyo Electron (OTC:TOELY) - Tokyo Electron manufactures semiconductor production equipment. TOELY's chip-making systems include chemical vapor deposition, thermal processing, etching, cleaning, and probing equipment. The company also makes flat-panel display (FPD) and photovoltaic (PV) production equipment.
Suzuki Motor Corporation (OTC: SZKMY) - Suzuki is a Japanese multinational corporation. Suzuki manufactures automobiles, four-wheel drive vehicles, motorcycles, all-terrain vehicles (ATVs), outboard marine engines, wheelchairs and a variety of other small internal combustion engines.
Down to these three stocks, I put on my stock-picker’s hat to find the biggest bargain with solid fundamentals. I followed a specific process for picking stocks as outlined in this post – The Informed Investors Checklist for Selecting Winning Stocks. Let’s zero in on fundamental analysis, starting with some valuation metrics.
All three stocks appear to be attractively valued in consideration of their earnings yield and PEG ratio.
The next set of metrics I looked at include Return on Equity (ROE), debt to equity and dividend yield.
Tokyo Electron pulls ahead of Sony and Suzuki across all three metrics. A high ROE shows Tokyo Electron does a good job allocating capital. A debt to equity ratio of 0 is hard to beat and will help when it comes to increasing their dividend yield – already an impressive 4.1%.
I personally eliminated both Sony and Suzuki before even completing the analysis because I don’t really understand the car manufacturing industry and its economics. And, I’ve never really bought into Sony’s business model, especially their content plays. These are just my personal opinions and perhaps other, more knowledgeable investors who better understand these two sectors would have a different point of view.
So, who is Tokyo Electron?
Let’s talk about Tokyo Electron. They are a semi-conductor company, but not like Intel or AMD. Tokyo Electron manufacturers the production equipment that companies like Intel and AMD use to manufacture semi-conductors. What I like about this is I don’t have to predict which semi-conductor company is going to come out with the next breakthrough and take the lead in the market. A bet on Tokyo Electron is a bet that the demand for semi-conductors will grow. Do you think our appetite for computers, phones, tablets, wearables and other devices that need smarts is growing or waning? That doesn’t even factor in the demand Tokyo Electron will likely see as more things get connected to the cloud. The company sees the Internet of Things as a big driver in years to come.
My bottom line
As with any investment decision you make it’s important to complete your own due diligence and assess if the investment matches your risk profile. Like any individual stock there is risk.
I believe Tokyo Electron is a good bet – they are undervalued, protected from Japan’s poor demographics as the majority of their revenue comes from outside of their local market, they have no debt and have shown earnings growth over the last five years. I decided to invest in Tokyo Electron and got in at $38.32. To account for the moderate-risk nature of this investment, I have drawn from my small pool of funds that I set aside to make measured and intelligent bets, bets that I do not take frequently, nor ones that would cause financial hardship if I am wrong. I believe Tokyo Electron fits the bill. This is not my first bet on a Japanese company – back in August of 2018 I shared my analysis and thesis for investing in Softbank.
The Investment Hypothesis for Tokyo Electron
Tokyo Electron has good fundamentals – they appear to be undervalued, have low debt, growing earnings and they are protected from poor demographics in their local market of Japan since most of their revenue comes from outside of Japan
Tokyo Electron stands to benefit from the continued proliferation of devices and the Internet of Things
What Could Go Wrong
Tokyo Electron could continue to be weighted down by the Tokyo Stock Exchange
In the short term, the semi-conductor market growth could be muted as smart phones saturate the market
What I Decided to Do
Begin a position in Tokyo Electron as a moderate-risk investment at the price of $38.32 (price on July 12, 2019)
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