ETF Teardown: Japan's Best Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks that share certain elements in common, so that if investors want to capitalize on the booming economy in Japan, for example, they can turn to iShares MSCI Japan Index (AMEX:EWJ) -- a contender for the best ETF of 2007 -- or the Vanguard Pacific Stock ETF.

But since these ETFs invest in a number of stocks, they give you a broad diversity that also limits your upside. For an investor who was, say, really hip to auto manufacturers in the region but cold on the future prospects of Japanese electronics makers, these ETFs wouldn't fit the bill.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best of what Japan has to offer. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, any of the 4,300 rated stocks that are profiled in CAPS can be "tagged" with a descriptor that groups the company with others that share a certain quality.

Selecting the "Japan" tag in CAPS presents a list of almost 30 Japanese investments that trade on American exchanges. This particular collection of investments has been stagnant in the past year, up only 0.4% versus the S&P gain of 13.2%. Yet many investors see great opportunities in some Japanese stocks that don't get the hype many Chinese and Indian firms receive -- and the overpriced shares that typically go with them.

To get a sense of which companies the CAPS community thinks are the best opportunities in Japan today, we can sort this list by their CAPS star rank, denoted by one to five stars, with five being the best. Each of the individual companies can then be viewed for exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company and why.

Getting down to the nitty-gritty
Here are a few of the five-star stocks our screen pulled up today.

Obviously, the CAPS community likes their Japanese cars -- or at least likes the prospects of automobile manufacturers in Japan. Beyond enjoying the benefits of increased sales for Honda and Toyota as U.S. automakers GM (NYSE:GM) and Ford (NYSE:F) struggle to connect with American consumers, investors see rising gas prices favoring the Japanese mix of more fuel-efficient wheels as well. Honda has earned a favorable rating from 774 CAPS investors, with only 19 voting for the company to underperform the S&P going forward.

CAPS investors are even more bullish on Toyota, with 1,782 investors giving the manufacturer the thumbs up and only 30 giving it a thumbs down. Investors are keen to point out Toyota's low trailing P/E of 14, compared to Honda's P/E of 26. Investors also like the leadership that Japanese auto manufacturers have shown in the hybrid and alternative fuel markets. With the trend of alternative energy and reduced fuel consumption effecting consumer behavior, investors believe Honda and Toyota are in the right place at the right time to capitalize on consumer buying trends.

And speaking of capitalizing on growing consumer trends, digital camera and imaging product manufacturer Canon is also highly regarded by CAPS investors. The company delivered a pretty picture of top-line growth in excess of 9% in 2006 and grew earnings by 17%. The clean balance sheet -- with $7.8 billion in cash and little debt -- also has investors smiling for the cameras. The company's solid product line and experienced management are just two reasons why all of the 67 CAPS all-stars weighing in on the company give it an outperform rating.

You can lead a horse to water ...
Plucking individual stocks from any foreign market is, of course, a more complicated endeavor, since there are many additional factors to consider first. Investors should always perform their own due diligence on companies rather than blindly take a recommendation -- after all, even the best stock pickers can be horribly wrong sometimes.

So do you agree that auto manufacturing is the best place to be in Japan? Or are Japanese electronics companies a better play? Give your own opinion in Motley Fool CAPS.

Global Gains lead analyst Bill Mann departs for China, India, and Taiwan on June 2 in search of new investment opportunities in some of the world's fastest-growing economies. Get updates and analysis live from the field by sending Bill an email at [email protected].

Fool contributor Dave Mock loves doing the teardown part -- it's the put-back-together part he hates. He owns no shares of companies mentioned here. Dave is the author of The Qualcomm Equation. Nintendo is a Motley Fool Stock Advisor pick. The Fool has a disclosure policy.