Three stocks to give your profits a far-from-cosmetic boost

Each week, a professional investor tells us where he'd put his money. This week: Michael Lindsell of Lindsell Train selects three cosmetics firms that are likely to be profitable in 20 years' time.

One of Lindsell Train's founding principles is to run client money as we would run our own which means to protect and, if possible, grow capital. The best chance of achieving this is by investing only in those companies that we judge to be exceptional. For us, exceptional means that they are likely to be profitably in business in 20 years' time. Because there are only a limited number of companies that meet our criteria, we run concentrated portfolios, with 20-30 holdings, and we rarely make changes. Here we look at three exceptional Japanese cosmetics companies. We like cosmetics as a business raw materials are cheap, yet end products are highly branded, aspirational items.

A radical turnaround for Shiseido

Shiseido (Tokyo: 4911)is one of the oldest cosmetics firms in the world, founded in 1872. It is one of the world's only global luxury brands with Asian provenance. The Shiseido brand is recognised worldwide and the company is dominant in Japan; it also has an important foothold in China.

We are encouraged that the company is now undergoing a radical turnaround. It spent 20 years seeing its market share decline in Japan with low profit margins and periodic inventory write-offs. Under its new CEO, Masahiko Uotani, it has rationalised its brands, acquired complementary businesses in Europe and the US, cut costs while increasing spend on targeted marketing, moved online and reinvigorated its business in China, where its brands are known for quality and reliability. Operating margins have also crept up to a new recent high of 8%. This has all fuelled continued performance from the shares that, encouragingly, still trade at a discount to the company's global competitors.

Lucrative opportunities in haircare

Haircare is a particularly lucrative business in Japan compared with the West. Interestingly, this is predominantly due to Japan's uniform hair colour, which creates more demand for differentiation. Mandom (Tokyo: 4917) specialises in selling haircare products and cosmetics for men, who are big consumers of such commodities. Mandom is more than 90 years old and remains a family business a feature we like, as family-controlled businesses tend to be more conservative and invest for the long term. Mandom's main brand is Gatsby, which accounts for 50% of sales, with a growing presence in Indonesia, where the company derives 25% of its sales. China also represents a strong opportunity.

Embracing customers is key

Another specialist cosmetics company we favour is Milbon (Tokyo: 4919), which produces branded haircare products for professionals. It has increased its market share by employing 250 field staff in Japan, who promote its products directly to beauty parlours and salons as well as conducting market research. No other competitor creates such a link with its customers and this, more than anything else, accounts for its rising market share. Milbon is also extending its business model into Asia mainly Korea, China and Thailand and the US; 13% of sales are derived from markets outside Japan. The firms's operating margins are 18%, which helps generate consistent 12% returns on equity, with an unlevered balance sheet.