How to Find the Best Japanese Stocks

Every now and then, we will turn our attention from our own traditionally productive stock market to a foreign bourse that has suddenly caught fire or found itself trending.

More often than not, that stock market will be located in one of the world's emerging markets – China, India, Brazil, or other parts of the world enjoying the brisk economic growth that developing nations are known for.

But the searing-hot international market capturing American investors' attention over the past year has been none other than … Japan?

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That's right: The island nation that's still trying to recover from its "Lost Decades" of economic stagnation has seen its stock market take off in fits and starts.

And if that's piqued your curiosity about investing in the country's equities, read on. We'll discuss what you need to know about Japan's recently volatile stock market, and what you should consider as you seek out the best Japanese stocks.

Why should I invest in the best Japanese stocks?

For those not familiar, Japan has spent most of the past 35 years mired in a long economic rut dubbed the Lost Decades. What started as both an economic and market bubble burst at the end of the 1980s and turned into more than three decades of mostly unchecked economic malaise and some of the deepest debt on the planet. 

Japan's economy has finally started to turn the corner over the past couple of years, and that's what's driving the recent rally in Japanese stocks that started in 2023. But those just discovering the country's equities should know that their main index, the Nikkei 225, has been in a sharp upturn for more than a decade. 

The late 2012 election of Prime Minister Shinzō Abe, and his subsequent "Abenomics" plan, put a jolt into equities – even if it had limited effect on the economy. The Nikkei is up more than 265% since then, lagging the S&P 500 by just about 20 percentage points. 

More recently, the Nikkei suffered its worst day since Black Monday, the global stock market crash in 1987, after the Bank of Japan's rate hikes caused the yen to rise  – putting a bunch of folks on the losing end of a carry trade. 

"[O]ver many years, investors have been borrowing in yen to invest in higher-yielding assets," writes the Schwab Center for Financial Research team in emailed commentary. "With interest rates rising [and] the yen moving higher, those trades are no longer profitable, and traders are unwinding them. The unwinding of leveraged trades in risk assets is taking on a life of its own because the size of the trades is large."

Japan's stock market since stabilized and the Nikkei has recouped most of its early August slump. And the BlackRock Investment Institute (BII) remains Overweight on Japanese stocks. 

"We like the virtuous circle of inflation driving wage growth – and thus corporate pricing power and earnings," the team wrote in a recent weekly commentary. "Corporate reforms aimed at adding shareholder value are also key."

Nikko Asset Management also sees reason for optimism in Japan's "decades-high implicit expenditure on software, typically a proxy for the type of spending corporates engage in when making honest attempts to increase the productivity of their businesses."

In the meantime, the economy, while hardly vibrant, has shown some life over the past couple of years amid a combination of aggressive fiscal and monetary policy and a lifting of COVID-19 restrictions.

Another factor driving interest in Japanese stocks is the media attention surrounding the stakes Warren Buffett's Berkshire Hathaway (BRK.B) has built in a handful of Japanese businesses. In his annual letter to shareholders, Buffett said Berkshire's unrealized gain in dollars in these investments at the end of 2023 was $8 billion.

How to find the best Japanese stocks

Picking the best Japanese stocks is pretty similar to picking the best stocks to buy here at home. Japan has a strongly regulated stock market where listed companies are required to provide quarterly and annual financial reports. Thus, there's a wealth of available information about virtually any company you'd be interested in. 

You'd evaluate Japanese stocks the same way you would evaluate U.S. stocks – by valuation, growth potential, balance sheet health, cash flow generation, and so on.

Really, when it comes to investing in Japanese equities, there's only one meaningful difference … but it's a pretty vital one that limits your choices.

That difference is access.

With a U.S. brokerage or retirement account, you typically can invest in any stocks or funds on all of the major U.S. exchanges (as well as over-the-counter, too). But they rarely provide access to foreign bourses – it's extremely unlikely that you could just type in a Tokyo Stock Exchange ticker and buy a few shares.

This means you're limited to Japanese companies that trade as American depositary receipts (ADRs) on either a major stock exchange or over the counter.

ADRs are certificates issued by a U.S. bank that represent stock of a foreign country – but they trade just like regular ol' U.S. stocks. ADRs must adhere to the requirements of whatever exchange they list on, so if they list with the New York Stock Exchange or Nasdaq, that communicates a higher level of accounting and transparency than might be required in their home markets.

Of course, the Tokyo Stock Exchange has thorough rules and regulations. So while over-the-counter stocks might normally be considered risky, Japanese stocks that trade on the TSE in Japan, but over-the-counter in the U.S., are quite safe. Consider that large and extremely well-known names including Nintendo (NTDOY), Nissan (NSANY) and Shiseido (SSDOY) all trade OTC. (Just make sure that they trade with sufficient volume; the three examples above are plenty liquid.)

And regardless of whether they trade on the NYSE, Nasdaq or OTC, if it trades as an ADR, its investor materials usually will be available in English – helpful to those of us who haven't brushed up on our Hiragana, Katakana and Kanji.  

If you simply don't have time to research individual stocks or prefer to diversify your Japanese holdings, you can always consider broad-based Japanese exchange-traded funds (ETFs). Among the best ETFs to buy are the iShares MSCI Japan ETF (EWJ), the currency-hedged WisdomTree Japan Hedged Equity Fund (DXJ) and the Franklin FTSE Japan ETF (FLJP).

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