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Stocks

Market Scramble: A way up for Japanese value stocks

Shift toward small-cap bargain equities indicates room for growth

The Tokyo Stock Exchange

TOKYO -- Investors here are suddenly yanking funds out of smaller but overvalued growth equities in favor of similarly sized bargain stocks, which may provide an opening for these components to finally shed their value label.

On Wednesday, the Tokyo Stock Exchange's startup-heavy Mothers board slumped 3.4%, its largest percentage loss since Nov. 9 -- just after the U.S. presidential election. This represented a dramatic reversal of the steady gains made by equities with small to midsized capitalizations.

Among the several underperforming small-caps is M3, which is down 3.5% since the end of last year. The operator of a medical information web portal has drawn equity funds focused on minor stocks. Hoshizaki, which makes ice machines for businesses, has dipped 3.2%

A portion of small- and mid-caps is strongly perceived to be overvalued, said Minoru Takada, chief fund manager at Mitsubishi UFJ Kokusai Asset Management.

Many of the small-caps are judged to be either overvalued or undervalued based on the forward price earnings to growth ratio. M3 sports a multiple of 2.7, based on the three-year profit growth projections provided by the QUICK FactSet data service. A reading above 2 normally indicates an overvalued equity.

Investors who have abandoned hopes for unreasonably pricey stocks have switched over to smaller companies that are undervalued due to such reasons as not having their headquarters in Japan's biggest cities, yet have growth prospects.

One of them is Hirata, a manufacturer headquartered in Kumamoto Prefecture. Analysts believe the corporation has a large margin for growth from its moneymaking semiconductor equipment business. Hirata stock has jumped nearly 20% since the end of 2016, but its PEG ratio stands at about 0.4, making it a real bargain.

An officer at Sparx Asset Management has a keen eye on the relative valuation of equities. Investment targets include Gakujo, which provides corporate information for new college graduates, and tech staffer UT Group. Although the two companies are poised to benefit from the labor crunch, their stocks are seen as undervalued. At the other end, short positions are being taken on convenience store chains and other similarly overvalued stocks, he said.

Bargain stocks face the so-called "value trap" in which their stock prices fail to improve. But despite that risk, investors are moving to these equities, holding out hope of better engagement with corporate management.

Atom Capital Management invests in value stocks and employs strategies toward maximizing their worth. "We engage in constructive discussions, such as enriching investor relations in the pursuit of proper stock valuations," said President Atsuko Tsuchiya. If managers at value companies enhance their focus on investors, the impact on share prices will be great.

On Monday, the TSE and Nikkei Inc. launched the JPX-Nikkei Mid and Small Cap Index, which picks 200 components based on qualities such as return on equity and the number of independent outside directors. The new index could push minor companies to reform corporate governance, leading them out of the perpetual value trap.

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