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Oakmark Funds Investor Letter - Even After a Rally, a Fundamental Case for Japan Remains

February 21, 2013 | About:

We’ve all been watching the Japanese stock market’s powerful rally over the last few months, driven mostly by a plummeting yen. Expected monetary loosening and possible economic reforms by a new prime minister have also helped the broad-market TOPIX Composite rise by more than a third between early October and mid-February.

Despite the recent rally, the Japanese equity market remains in our view the most undervalued of all of the developed countries. A majority of the companies in the TOPIX trade around book value, and many trade at prices below their net cash value. This valuation does not reflect the fact that many companies are experiencing increased business activity, strong free cash generation and dividend yields that surpass those of the S&P 500.

Of course, the fact that Japanese equities look cheap on paper doesn't by itself mean they are a value – it’s only a reason to dig a little deeper into the story. We’re doing that digging and we continue to find equity opportunities in Japan that stretch across the market-cap spectrum and across a number of themes.

Here’s a quick look at fundamental reasons why, in our opinion, there remains tremendous long-term potential in select Japanese equities.

Streamlined operations: Global competition and years of dealing with a strong yen have pushed Japanese exporters toward greater efficiency in their operations. This has included reducing wages at home and moving a significant share of their production overseas. This stands to serve them well regardless of the currency environment.Sharing more with shareholders: The tendency of Japanese companies to hoard cash has been changing over the past decade and even more so in recent years. Dividend payouts now are estimated at about four times their level a decade ago, and there is a good chance that a share buyback record set last year will be topped this year.Better corporate governance: Japan is making steady progress in bringing greater transparency, diversity and accountability to its corporate boards. An increasing number are adding independent directors and outside auditors to better hold management accountable for its performance.Geographic advantage: Japanese firms are benefiting from their proximity to emerging East Asia, home to some of the world’s fastest-growing economies. Many now earn a significant share of their profits in neighboring countries, and their strategies call for them to push deeper into those markets.Opportunities at home: Despite Japan’s aging population and decades of deflation, growth prospects also exist at home. It remains the world’s third-largest economy and household disposable income is above average for the developed world.Innovators stepping up: In its post-World War II heyday, pioneering Japanese manufacturers disrupted a number of global industries – automotive, consumer electronics, steel production. These days new innovators are emerging in other fields, including laser technology, communication and industrial automation.[/list]Our investment case for Japan does not depend on headline-grabbing macroeconomic moves aimed at stimulating near-term growth. As long-term value investors, we seek out quality companies priced at a significant discount to our estimate of intrinsic value, with proven management teams and a path to sustainable growth.

We remain excited by individual company opportunities that we see in Japan that fit our investment criteria. We believe these underappreciated companies will continue to prosper in the increasingly global economy.

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