Value investors think the good times are far from over for the Japanese stock market. Here are stocks and funds to invest in now. Reshma Kapadia
Japan has had more than its share of challenges lately, chief among them energy shortages, higher costs from the closure of the Strait of Hormuz, and questions about Prime Minister Sanae Takaichi's ambitious fiscal spending plans.
That hasn't stopped investors from snapping up shares of Japanese stocks. The Nikkei 225 is up 18% this year -- and 47% over the past five years. Working in Japan's favor are shareholder-friendly governance reforms in the private sector and increased demand for Japanese services and goods as nations race to revitalize manufacturing and reduce reliance on China.
Investors looking for value say there's more to come.
Even after the latest gains, the MSCI Japan index trades at under 18 times forward earnings -- a discount to the almost 21 times for the S&P 500. Analysts have boosted their earnings expectations for Japanese companies since the start of the year. After about a third of companies reported their results for the fourth quarter of fiscal 2025, which ended in March, Société Générale analysts noted that earnings growth averaged about 18%, suggesting full-year earnings per share growth of 7.5%.
U.S. Treasury Secretary Scott Bessent's recent visit to meet with top Japanese officials, including Takaichi, highlights the opportunity ahead, especially for Japanese industrial companies that help the U.S. and other countries shore up critical supply chains. As part of its trade pact with the U.S., Japan committed to a $550 billion investment program to help fortify Western economies from reliance on -- and competition from -- China. The first projects have been directed at power generation, oil and gas, and critical minerals.
As the U.S. shifted into services over the past couple of decades, Japan preserved its manufacturing infrastructure, sometimes sticking with unprofitable operations. That manufacturing prowess is now increasingly valuable. Christian Heck, a fund manager and deputy head of value at First Eagle Investments, says the Japanese economy's aging and shrinking population means it has been early in areas like factory automation, and can now take the skills it has honed abroad. "Any sort of reshoring or onshoring means you need highly automated factories. There isn't enough labor, and labor is too expensive," Heck says.
One of Heck's cheaper holdings is SMC Corp., a world leader in pneumatics equipment manufacturing. The company's 40% global market share is still growing -- its business requires millions of parts, making it harder for rivals to break in. That has allowed SMC to generate ample free cash flow, high returns on invested capital and strong margins. The company has invested heavily recently to increase its capacity, which Heck thinks can deliver mid- to high-single-digit revenue growth over time and a stock return in the teens.
Japan also benefits from the push to find other sources of critical minerals and lessen reliance on China. About a decade ago, Japan discovered a large, deep-sea rare earth deposit that is considered the world's third-largest high-quality, mineral-rich rare earth reserve. The deposit includes yttrium and dysprosium used in permanent magnets, clean-energy technologies, and advanced chemicals.
Japan has the infrastructure to develop these reserves and has recently outlined a plan to commercialize it, says Masakazu Takeda, co-manager of the Hennessy Japan fund. One potential beneficiary in Takeda's portfolio: Shin-Etsu Chemical, a silicon wafer and PVC manufacturer, that also has a rare-earth business that could help commercialize the reserves. Though Takeda says the company's role in building infrastructure was the draw, the rare-earth component is an added benefit.
Japanese companies are also taking a bigger role in the U.S. housing market. Sumitomo Forestry's recent acquisition of Tri Pointe Homes makes it one of the top builders in the U.S. Sumitomo is looking to consolidate the fragmented U.S. housing market. Though Sumitomo's shares have lagged behind the broader market as home buyers struggle with affordability in the U.S., Takeda says it's a matter of when, not if, the market turns.
The dynamics at home also bode well for some companies. Japan is facing inflation for the first time in decades, with core inflation rising 2% to 3%, unfathomable a decade ago in the depths of Japan's deflationary rout. Among the beneficiaries are banks and cash-rich companies that avoid higher borrowing costs and earn meaningful interest on their cash.
Inflation has another advantage. "Our companies have pricing power but have never used it because it was seen as un-Japanese to raise prices. Now, all of a sudden, it is acceptable," says Heck. Hoshizaki, which makes ice makers for restaurants and other commercial uses and benefits from relatively stable demand, has increased prices several times since Covid after a 20-year period of no such hikes. "For the businesses we own, that mentality change -- that price increases are socially acceptable -- has been beneficial," says Heck. "Pricing is a very important lever because it flows right through to the bottom line."
At the same time, Japanese government borrowing costs have surged, with the 10-year yield hitting 2.75%, its highest point since 1997. The sharp move in the bond market reflects investor concerns that the Bank of Japan might be moving too slowly to deal with inflation exacerbated by Takaichi's efforts to blunt the higher energy prices with fiscal stimulus.
Still, the government's push for companies to start deploying their cash has attracted foreign investors, especially with the Tokyo Stock Market's "naming and shaming" campaign targeting companies trading below price-to-book value. The exchange is now looking to send a stronger message by revising its corporate governance message to get companies to stop hoarding cash.
Roger de Bree, managing director and fund manager at Tweedy, Browne, invests with an eye for bargains, and sees Japan as a fertile place to invest. Koito Manufacturing, which makes lights for cars and laser safety systems, said in 2025 it would buy back 350 billion yen worth of shares. So far, the company has bought back 50 billion yen. That has boosted the stock, but the company still has room to do more. By his analysis, the company is currently trading at about 10 to 11 times next year's expected earnings.
"The country is slow to adopt new things, partly because culturally it is slow-moving," Takeda says. "There is always initial resistance to change. The flip side is that once momentum sets in, it can turn into a significant movement."
Japanese policymakers have been intervening in the currency market to stem the slide in the Japanese yen. In a note to clients, Société Générale currency strategist Kit Juckes said the yen is likely closer to a recovery. Although the Bank of Japan kept rates at 0.75% at its last meeting, three board members dissented, and SocGen analysts expect the central bank to raise rates soon.
Several major brokerages allow investors to trade on the Japanese stock exchanges. But investors can also gain a foothold more easily in Japan with the iShares MSCI Japan exchange-traded fund or, for those worried the yen won't shake off its weakness, the WisdomTree Japan Hedged Equity ETF.
A stronger yen could bolster confidence domestically, encouraging Japanese households to invest more at home. Already, Japan has offered nudges like expanding tax-exempt investment accounts to woo some of the $7 trillion, or half of Japanese households' wealth, that has been parked in cash into equities.
Japanese retail investors have just 14% allocated to stocks. If they inch nearer to Europe's 25%, Morgan Stanley estimates that could translate to $1.7 trillion in equity purchases. That's about 20% of the market cap of Tokyo Stock Market Prime Exchange, which lists the biggest companies.
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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May 22, 2026 21:30 ET (01:30 GMT)
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