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Stocks

Little-covered Tokyo small caps take turn in the spotlight

Quick reaction to earnings news seen giving stockpickers an edge

TOKYO -- Investors seem to be seeking out small- and midcapitalization Japanese equities that attract few analysts but respond more readily to earnings news than index-investment-driven blue chips.

"It's gotten harder to invest in large caps," said one retail investor in his 30s who has been in the stock market for over a decade. He prefers to hunt smaller game than blue chips that tend to budge little on earnings reports, good or bad, in a market distorted by institutional buying.

Easy to rise

Small- and midcaps held firm Tuesday even as the Nikkei Stock Average closed below the psychologically important 20,000 mark again. The index for the Tokyo Stock Exchange's second section climbed for a sixth straight session to a new record, while the Nikkei Jasdaq Stock Average soared to a roughly 27-year high.

Companies that had reported strong earnings the previous day gained sharply, including business and home software developer Solxyz, which added 11%, and Japan Pure Chemical, which makes chemicals for metal plating. Its shares climbed 9%.

A common thread linking these gainers is thin analyst coverage. Some institutional investors require analyst forecasts to add stocks to their portfolios. With little investment information to go on, investors tend to overlook these shares, leaving them undervalued and prone to climbing easily on strong earnings news.

Stocks with low price-earnings ratios covered by fewer than five analysts have far outperformed ones covered by 10 or more analysts, says Tomohiro Okawa at P.S. Oskar Group. The fewer the analysts, it appears, the more potent the charm.

Last year, the Japan Securities Dealers Association clamped down on analyst interviews taking place shortly before financial reports are issued, and as a result, analysts are covering fewer stocks. Around 40% of shares on the TSE's first section are now covered by five or more analysts, down from over half five years ago.

"With the volume of investment information declining and passive investing gaining momentum, the tendency to favor small- and midcaps with few analysts will probably keep increasing," Okawa said.

Bigger but bulkier

Large caps tend to be routinely bought regardless of earnings performance, owing to supporting factors including the Bank of Japan's massive purchases of exchange-traded funds. At the end of June, passive investment accounted for 32.5% of assets under management in publicly offered mutual funds, the highest level in data reaching back to 2010.

"Small- and midcap stocks respond more readily to earnings," said Fumio Matsumoto at Dalton Capital (Japan). The shares are easily whipped around by a multitude of factors, including macroeconomic movements and geopolitical risk.

There are still plenty of bargains to be found among these shares, even those recently hitting year-to-date highs. Industrial electronics supplier Sun-Wa Technos has soared 90% this year, yet it is trading at slightly more than 11 times forward earnings. Precision motion equipment maker Sinfonia Technology has likewise gained more than 80% but has a multiple of just over 14 -- about the same as for the Nikkei average, which is up only 4.4% this year. Taking the road less traveled, as the old market proverb says, looks likely to continue to lead to investment opportunities.

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