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Stocks

Japanese shares clinging to hope of escaping low valuations

TOKYO -- Even as the Nikkei Stock Average faltered Tuesday, shares in Uchida Yoko jumped 14% after the office supplies distributor reported a 53% net profit gain for the year ended July 31.

     Corporate cost-cutting took its toll on Uchida Yoko: businesses struggling against deflation do not tend to indulge in new furniture or electronics. So the company set out to make customers of schools and municipal governments. It managed to turn a profit in the year ended July 2013 after four straight years in the red.

     Investors had been content to let cash-rich Uchida Yoko's shares languish. Even after Tuesday's run-up, its price-to-book ratio comes to just 0.75 -- still less than liquidation value.

     But investor perceptions do appear to be changing, and the same seems true for other downtrodden stocks. Car seat maker Tachi-S, bearings manufacturer Nippon Thompson, Sakai Chemical Industry, and a number of other companies trading below book value have all taken in fresh investment, judging by recent disclosures filed by shareholders when their stakes top 5%. More small- and midcap companies say they are getting visits from investors, according to Takashi Murakami of SMBC Nikko Securities.

     Shares with P/B ratios under 1 may look cheap but are often consigned to the bargain bin for a reason. Investors drawn by the prospect of selling high may get caught in a value trap, a risk long associated with the Japanese market. Indeed, 40% of stocks on the first section of the Tokyo Stock Exchange are trading below book value.

     This may change, reckons Yoshito Sakakibara of JPMorgan Asset Management (Japan). The secular market downturn that followed the bursting of the Japanese bubble economy is coming to a close, and investors will start reappraising corporate profitability, Sakakibara contends. Should deflation give way to healthy inflation, hard-fought efficiency gains achieved when prices were falling will start paying off in spades. Return on equity provides an indispensable gauge of progress on this front.

     Of course, some stocks will be left behind. What is important is whether a company "can increase its profitability amid a changing environment," says Masayuki Kubota of Rakuten Securities.

     NEC, whose P/B ratio climbed back above 1 in January, has managed to rekindle investor hopes with a bold overhaul of operations. Such steps as abandoning the smartphone business have restored profitability.

     Staying above book value is only one step toward normal. Next comes adopting "the mindset to be dependably profitable," UBS Securities Japan's Tomohiro Okawa argues. Japanese companies may lag far behind their American peers in squeezing returns out of capital, but an optimist might say they have that much more potential for change.

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