Fund manager David Herro says that for many Japanese companies, shareholder interests aren't a big enough priority. By Katy Marquardt, Staff Writer July 2, 2007 Investors should approach Japanese stocks with care, says David Herro, chief investment officer of international equities at Harris Associates. "There are still unique problems in Japan, which should give investors cause for concern," says Herro, who spoke in late June at the Morningstar Investment Conference, in Chicago. "Corporate Japan is still struggling with the premise that the primary purpose of a company is to make money for its shareholders."When Herro speaks, it pays to pay attention. He manages Oakmark International (symbol OAKIX), a member of the Kiplinger 25, and Oakmark International Small Cap (OAKEX). Over the past ten years through June 30, Oakmark International returned 11.5% annualized, placing it in the top 30% of value-oriented, large-company overseas funds. International Small Cap returned 15.4% annualized over the past decade, also in the top 30% of its category (funds that invest in undervalued small and midsize foreign companies). Small Cap is closed to new investors. Herro points out that the return on equity (ROE) -- a measure of profitability -- for the average Japanese company is 7% to 8%, or "about half of what we're seeing in the U.S." He notes, for example, that executives at Toyota Motor (TM) aim to generate an ROE of 10%. "Why not shoot for the 16% to 18% ROE that many U.S. companies generate?" he asks. This isn't a new issue for Herro. In his funds' first-quarter commentary, he wrote of the difficulty he has finding attractive, bargain-priced Japanese stocks. "Generally speaking, the shareholders do not appear to be a high-ranking constituency in the eyes of corporate Japan." Both funds recently had about 13% of their assets invested in Japanese companies (the MSCI EAFE index, a widely followed barometer of overseas stocks, has 21.5% in Japan). Advertisement When searching for Japanese stocks, Herro says, he looks for companies that trade at a discount to what he thinks they're worth and are run by managers who place a high priority on building shareholder value. Among his favorites are Rohm, a Kyoto-based semiconductor manufacturer, and auto maker Honda (HMC). "The biggest plus [for Japan] right now is that there's so much that can be done, if only it were allowed to happen," Herro says. The minus, he adds, is that the Japanese are slow to change. Herro has about 70% of Oakmark International's assets and 60% of International Small Cap's assets in European stocks, but he's not pounding the table for Europe. "As we sit here today, I'm less enthused about European equities," he says. "Those tailwinds we've had for the last five or six years are diminishing."