It's Time to Buy Japan's World-Beaters!

First things first: If you have not already done so, I urge you to give to the relief effort in Japan. Here are several ways to do that effectively.

As I previously argued, the impact of the Tohoku earthquake will be massive in parts of the Sendai region, but relatively small at the national level. While the Japanese stock market has recovered some of the losses it suffered in the days immediately after the quake, opportunity remains for alert investors. The Japanese market was cheap before the quake, and it's even cheaper now. In that context, I've put together a basket of world-beating Japanese companies that investors can buy now.

Japan is plain cheap
As Chuck de Lardemelle and Charles de Vaulx, portfolio managers of the top-rated IVA Worldwide and IVA International Funds, observed on March 15, "in terms of absolute valuation ... the Japanese markets as a % of Japanese GDP, is now close to the lows reached at the major 2003 and 2009 bottoms."

As the following table illustrates, the Japanese counterparts of some well-known U.S. companies are often cheaper on the basis price-to-12-month forward earnings. (The forward P/Es are shown in parentheses after each name.) Investors can purchase all the Japanese stocks in this table on the New York Stock Exchange:

Source: Capital IQ, a division of Standard & Poor's.

The world-beater basket
If you are willing to invest directly in Japanese stocks, rather than buying a fund such as the iShares MSCI Japan Index ETF, I stronly recommend that you widen your universe to consider shares that are traded in the over-the-counter market. In that context, I've put together a "Japan's World-Beaters" stock basket:

Source: Capital IQ, a division of Standard & Poor's.

Because of the economic malaise that has hobbled Japan for the past two decades, we have become accustomed to thinking of anything that relates to the Japanese economy -- including its companies -- as moribund.

That's wrongheaded on multiple levels. First, Japan is much more entrepreneurial than people realize, with numerous small business owners. Second, the great Japanese companies are intensely focused on product quality and customer satisfaction, and they are very tough competitors in global markets, whatever the state of their home market. Here are two examples of that from the preceding basket:

Fanuc
Fanuc controls provide the "brains" that operate an estimated 60% of the world's precision machine tools. With operating margins of 40% (higher than Google), the company's profitability reflects that dominance. As a representative from one Swiss manufacturer told Bloomberg last year: "They're expensive and have a monopolistic attitude... As a customer, you feel powerless." Friends, that is a textbook definition of pricing power -- a sure sign of a competitive advantage -- and music to an investor's ears. At roughly 22 times normalized trailing earnings, the stock doesn't look wildly cheap. Then again, businesses of this caliber rarely are.

Shimano
Shimano sets the standard in terms of bicycle parts. They own somewhere between 50% and 70% of the global market for derailleurs (the mechanism that moves the chain from one set of gears to another when you shift gears). To describe the quality of this business, I can't put it any better than Abhay Deshpande, portfolio manager at First Eagle Funds, did at the end of 2009:

They generate incrementally more profit and cash flow every year on a declining capital base. It's the very definition of a good business. It requires very little capital to run it and every year they have a pretty stable market share.... When we're at the factory... you get a sense of how their very singular focus on a core business over a long period of time has generated outsized returns, an increasing competitive advantage vis-a-vis their competitors...

That's the sort of business you want to own in your portfolio.

Disaster as a positive catalyst?
In the wake of this tragedy, the Japanese have earned a new respect abroad by demonstrating that they are resourceful and resilient, and that they can achieve impressive results when they mobilize their energies toward a common goal. That's exactly what Japan's global leaders do on a daily basis. I think the spotlight the Tohoku earthquake has shone on Japan could prove an effective catalyst for international investors to rethink their attitudes toward Japanese stocks. Investors who act ahead of that process will reap the benefits over time.

To track the shares mentioned in this article, add Toyota, Canon, and NTT Docomo to your watchlist, or start a new watchlist and add any company you want. You'll get valuable updates as well as immediate access to a new special report, "Six Stocks to Watch from David and Tom Gardner." Click here to get started.