Finding Growth Opportunities in Japan’s Small Cap Space

Warren Buffet has recently increased his stake in five major Japanese trading firms, reflecting his optimism in the long-term potential of the world’s third-largest economy. As reported in an article from Japan Today, Berkshire Hathaway now controls 7.4% of each of these conglomerates, which include Itochu Corp, Marubeni Corp, Mitsubishi Corp, Mitsui & Co, and Sumitomo Corp.

While these large-cap corporations may provide stability and dividends, they are not the prime source for growth opportunities in Japan. In this article, we will explain how foreign investors can uncover growth potential in Japan’s small-cap sector by capitalizing on market inefficiencies arising from information asymmetry.

The Undervaluation and Neglect of Japanese Small Cap Companies

Japanese small-cap companies typically trade at lower valuations in comparison to their counterparts in other markets, a result of factors such as low interest rates, deflationary pressures, and risk aversion among domestic investors. According to Hennessy Funds, Japanese equities offer compelling valuations compared to other developed equity markets and relative to their own historical averages.

For instance, Japanese large-cap equities, as represented by the Tokyo Price Index (TOPIX), were trading on a price-to-earnings (P/E) multiple of 11.6x 2022 forward earnings as of December 2022, nearly 29% lower than the U.S. Furthermore, on a price-to-book (P/B) basis, Japanese equities present great value compared to other global developed equity markets, with TOPIX trading at just 1.1x book value. This is about a third lower than the average among the top developed equity markets and more than two-thirds lower than the U.S.

Small-cap Japanese companies were also trading at a discount to international peers, as of December 2022, with their stocks trading at just 11.2x 2022 forward earnings—a 44% discount to U.S. small caps, which were trading at 19.9x. Additionally, Japan’s 2022 forward P/E multiple was lower than its 10-year average of 14.3x, further emphasizing the attractive valuation levels of Japanese equities.

One of the reasons for the undervaluation of small-cap Japanese companies is the lack of research coverage, as they often receive less attention from institutional investors and analysts. The language barrier is a key contributor to this situation, as many Japanese small-cap companies do not provide English materials or investor relations services, making it challenging for foreign investors to access information and engage with management.

Matthews Asia’s blog post, “The Alpha Potential in Japan’s Small Caps,” highlights thin research coverage as one of the driving factors behind the undervaluation of small-cap Japanese stocks. According to the post,

“Of the more than 1,900 Japanese small-cap equities, over 1,400 have fewer than three analysts covering them, and more than 900 are not covered by any analysts at all.”

This lack of coverage results in Japanese small-cap companies being under-researched and under-followed by market participants.

This information asymmetry, particularly for those who cannot access and comprehend Japanese information sources, leads to a deviation from the efficient market theory in the Japanese small-cap sector. The efficient market theory assumes that all relevant information is factored into a stock’s price, but in the case of Japanese small-cap companies, this information imbalance creates a unique environment that could generate alpha for investors who can capitalize on it.

Taking Advantage of Information Asymmetry as Investors

Foreign investors can employ various strategies to bridge the information gap and gain an advantage in the market. One approach is to explore English resources or utilize online tools to translate Japanese materials.

Shared Research

A number of English resources can assist foreign investors in gathering information about Japanese small cap companies. These include the Nikkei Asian Review, a prominent business publication covering news and analysis on Asian markets, including Japan, and the Japan Times, the largest and oldest English-language newspaper in Japan, which addresses a wide range of subjects, such as business and economy. Independent research platforms like Shared Research offer detailed reports on over 300 Japanese small and mid-cap companies, while financial information service companies like FISCO provide news, analysis, and research reports on small and mid-cap companies.

Foreign investors can also access official filings and disclosures from Japanese companies through government resources like EDINET, a database containing financial reports, securities reports, quarterly reports, and other documents submitted by listed companies to the Financial Services Agency of Japan, and TDnet, a database featuring timely disclosure documents such as earnings releases, business forecasts, shareholder meeting notices, and corporate governance reports submitted by listed companies to stock exchanges.

Screening tools are valuable resources for foreign investors seeking potential investment opportunities among Japanese small cap companies. Buffett Code is a web-based tool that enables users to screen and analyze over 3,800 Japanese listed companies based on various financial metrics and indicators.

Another method to overcome the language barrier is the utilization of translation tools capable of providing reliable translations for materials available exclusively in Japanese. DeepL, an online translation tool powered by artificial intelligence, offers natural and accurate translations. With the DeepL Pro plan, users can even translate PDFs.

Investors can also take advantage of ChatGPT to summarize the key points of Japanese texts in English. This AI-based tool can help make Japanese materials more accessible to non-Japanese speakers. For sensitive materials or more complex translations, investors can access our services page to hire us for professional translation services.

In order to bridge the information asymmetry and gain a better understanding of Japanese small-cap companies, investors can explore a comprehensive list of resources here. These resources will enable you to effectively navigate the Japanese market, identify undervalued stocks, and capitalize on the growth potential in this sector.

Identifying Multi-Bagger Opportunities in Japan’s Small Cap Growth Sector

Our primary focus is on discovering multi-bagger investment opportunities within Japan’s small cap growth sector. Multibaggers refer to stocks that can multiply in value several times over a certain period, while the growth sector encompasses industries with high growth potential or those undergoing significant structural changes.

Some small cap growth companies in Japan have characteristics similar to series A, B, or C startups in the US private market, such as high growth potential, low debt, and strong competitive advantage. These enterprises exhibit rapid growth in revenue and possess scalable business models with the ability to expand into new markets or segments. By investing in these companies early on, before they gain widespread recognition in the market, investors have the opportunity to capitalize on substantial upside potential.

Lasertec Corporation

A few examples of Japanese companies that have experienced significant increases in market cap in recent years include:

  1. Lasertec (TSE:6920) – Lasertec is a leading developer and manufacturer of inspection and metrology equipment for the semiconductor and flat panel display industries. The company has seen rapid growth due to the increasing demand for advanced semiconductor technologies.
  2. MedPeer (TSE:6095) – MedPeer is an innovative online platform that connects medical professionals and provides them with the latest medical information and research. The company’s growth has been fueled by the increasing need for digital solutions in the healthcare sector.
  3. Katitas (TSE:8919) – Katitas is a real estate company specializing in the purchase, renovation, and resale of existing residential properties in Japan. The company has capitalized on the demand for affordable and well-maintained homes in the country, resulting in significant growth in its market cap.
  4. Rakus (TSE:3923) – Rakus is a provider of cloud-based software solutions for businesses, focusing on customer relationship management (CRM) and enterprise resource planning (ERP) systems. The company has experienced rapid growth as more businesses transition to cloud-based software solutions.
  5. (TSE:6027) – is an online legal services platform that connects clients with lawyers and offers various legal-related services. The company has grown steadily as more people and businesses seek efficient and cost-effective legal solutions online.
  6. SHIFT Inc. (TSE:3697) – SHIFT Inc. is a software testing and quality assurance company that helps businesses ensure the reliability and security of their software products. The company’s growth can be attributed to the increasing demand for high-quality software and the need for thorough testing in today’s digital world.

These companies illustrate the potential for substantial growth in the Japanese small-cap sector, and investors who identify such opportunities early on can reap significant rewards.

Introducing the Satori Stocks Blog Series

Japan’s small cap sector presents lucrative growth opportunities for foreign investors willing to invest time and effort into understanding the market more deeply. By capitalizing on the information asymmetry resulting from language barriers and limited analyst coverage, investors can uncover undervalued and underappreciated gems with the potential to become multi-baggers over time. We trust this blog post has provided you with valuable insights and ideas on investing in Japan’s small cap space.

To further assist investors in navigating this under-researched market, we are launching a blog series called “Satori Stocks.” This series will focus on our analysis of potential multi-bagger growth stocks in Japan, helping investors bridge the information gap in Japanese growth stocks. The name “Satori Stocks” was chosen intentionally, as “Satori” means enlightenment in Japanese. Unlike “story stocks,” which can sometimes be delusional or fabricated, Satori Stocks aims to provide investors with a clear and enlightening perspective on investment opportunities in Japan. This series will help ensure that investors are not trapped in misleading narratives but instead attain enlightenment or “Satori” and leverage multi-bagger opportunities in this under-explored market.

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