Japanese small cap stocks rebound

published 3 June 2015

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week:Shinji Higaki, portfolio manager, Fidelity Japanese Values.

I started my investment career as Japanese equity analyst at Fidelity's Tokyo office 16 years ago. I covered a number of sectors, including consumer staples, materials, capital goods, and information technology. I trained myself to be a bottom-up stockpicker focusing on individual company's fundamentals.

When choosing stocks, I look closely at a company's business model, particularly in terms of its sustainability and barriers to entry, followed by valuations, liquidity, and the potential upside versus downside. The track record of management in boosting shareholder returns is also key.

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Small caps have been relative laggards in the Japanese market this year. Investors have favoured blue chips that are embarking on big profit-sharing programmes, such as dividend hikes and share buybacks. But I believe small caps are well placed to deliver strong earnings growth in the long run, a potential that is still under-recognised by investors. Factors that should drive earnings include a cyclical upturn in demand for electronic components, global economic growth, new healthcare services and corporate governance reform.

I visit companies regularly to find investment opportunities in under-researched, undervalued, medium-sized and small companies benefiting from such long-term growth drivers. Being relatively young and dynamic, small companies can often create their own niche market and so may be able to grow their businesses, regardless of the economic backdrop.

Currently I'm maintaining a diversified portfolio with exposure to companies benefiting from global growth, those creating their own niche, or those driving change in their own industry.

M3 (Tokyo: 2413) operates medical portal sites dedicated to healthcare professionals in Japan, the US, South Korea and Europe. It's a good example of a company that is creating its own niche by providing solutions to customers' problems. Its strong earnings growth is being driven by overseas expansion, particularly in China.

The company also provides large-scale clinical-trial services for pharmaceutical companies, which should help to drive growth in the medium to long term. M3 has consistently added value over time since we first bought into it in 2007.

Hamamatsu Photonics (Tokyo: 6965) is the world's top supplier of ultrasensitive light sensors with potential uses in a wide range of fields, from medicine and dentistry to scientific research and transportation. It has a competitive niche in the global diagnostic imaging equipment market, with exposure to high-profit-margin CT scans, MRI, and digital X-ray systems.

Demand for these products is growing rapidly in developing countries as their medical infrastructure expands. The firm has a proven track record of creating shareholder value its return on equity is now over 11%.

WirelessGate (Tokyo: 9419) is a mobile virtual network operator that provides Wi-Fi services in public spaces in Japan. The rising penetration of smartphones and tablets, alongside larger data downloading requirements, is encouraging more users to adopt Wi-Fi services. Meanwhile, the Abe government is prioritising expanding Japan's Wi-Fi infrastructure.

All of this is very favourable for WirelessGate's business. Although profit margins are currently under pressure due to the start-up costs of a newhigh-speed connection service, I believe itslong-term growth story remains attractive.