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TheStreet Open House

Will growth in the Japanese economy lift these 3 stocks?

Stocks in this article: CAJ IX NTT

By Mary-Lynn Cesar for Kapitall.

The Japanese government revised its first-quarter growth reading on Monday, saying that higher capital spending helped the economy grow at an annualized rate of 6.7% instead of the previously stated 5.9%.

Capital spending, also known as capital expenditure, is the money companies invest in things like new facilities and equipment, and is an indicator of domestic demand. Japan's increase in capital spending during the first quarter was revised to 7.6% from 4.9%. 

Both Japan's initial and revised GDP readings beat expectations, which  Reuters reports placed growth at 5.6%. And the economy's expansion was its fastest since  2011. 

However, many are skeptical that Japan can continue its economic expansion in the wake of the recent sales tax hike. The increase, which upped the sales tax from 5% to 8% on April 1, drove customers to stores in droves in March as they tried to beat the deadline. It also resulted in the fastest growth in retail sales in seventeen years.

But in April, consumer spending fell at its fastest pace since 2011. And while Prime Minister Shinzo Abe expects more companies to raise worker wages in an effort to boost the economy and consumer spending,  The Japan Times reports that the average monthly income for salaried households in fell 7.1% in April from the prior year in real terms. The slow pace of worker wage growth has some doubting that consumer spending will increase enough to nullify the tax hike's impact.

Yet, even though Japan's GDP is expected to contract in the next quarter, the Bank of Japan holds that the third quarter will see a return to a moderate recovery. And the increase in capital spending combined with May's rise in consumer confidence—the first such instance in six months—and an improvement in service sector sentiment could support the BOJ's stance. In May, the service sector sentiment index, which measures confidence about the current economic environment, rose to 45.1 from 41.6 in April. The outlook index climbed to 53.8 from 50.3 indicating that workers in the service sector are increasingly optimistic towards future economic conditions.

Today's GDP revision inspired us to look for investment opportunities amongst Japanese stocks, and we decided to run a screen for investors that side with the BOJ on the future of Japan's economy. We began with a group of Japanese stocks that trade on US exchanges. Next, we screened for stocks that are  rallying above their 20-day, 50-day, and 200-day simple moving averages (SMA). This indicates that these stocks have strong upward momentum.

We then screened for stocks that are potentially  undervalued with a low price-to-sales (P/S) ratio. This valuation metric compares share price to what a company has generated in revenue over the last twelve months. A low P/S ratio may indicate that a stock's price is cheap in relation to the company's revenue, and when a stock's P/S is under 1, it may be considered undervalued. Though it's important to note that expenses and debt aren't incorporated into the ratio, and variations between industries is standard. For the following list, we screened for stocks with P/S ratios under 2, meaning that the company’s market cap isn’t greater than 2x its annual sales.

We were left with four stocks on our list. Do you believe that these stocks have upside potential, given the challenges facing the Japanese economy? Use this list as a starting point for your own analysis.

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