Part of California-based Hennessy Advisors, the fund is managed by Tadahiro Fujimura and Tetsuya Hirano. Focusing on sustainable growth while limiting downside, the portfolio managers invest in a concentrated number of growth-oriented, small-cap Japanese companies that have a strong balance sheet, a durable competitive advantage, a high return on equity, above-average earnings growth and strong cash flow generation.
Based on these criteria, the fund's top four new buys for the quarter were Star Mica Holdings Co. Ltd. (TSE:2975), Parco Co. Ltd. (TSE:8251), Tokyo Ohka Kogyo Co. Ltd. (TSE:4186) and Towa Corp. (TSE: 6315).
The fund invested in 94,700 shares of Star Mica, dedicating 1.17% of the equity portfolio to the position. The stock traded for an average price of 1,622.93 yen ($14.96) per share during the quarter.
The real estate services company has a market cap of 33.7 billion yen; its shares closed at 1,905 yen on Friday with a price-earnings ratio of 50.79 and a price-book ratio of 13.47.
The price chart below shows the stock has gained more than 50% since its initial public offering in June.
GuruFocus rated Star Mica's financial strength 5.4 out of 10 as a result of having no debt and comfortable interest coverage.
Despite having strong margins that outperform a majority of competitors, the company's profitability scored a 1 out of 10 rating as its returns are weak.
The fund holds 0.52% of Star Mica's outstanding shares.
After selling out of Parco in second-quarter 2016, the Japan Small Cap Fund established a new 120,900-share holding, allocating it to 0.98% of the equity portfolio. During the quarter, the stock traded for an average price of 1,105.86 yen per share.
The Tokyo-based department store chain has a market cap of 130.92 billion yen; its shares closed at 1,289 yen on Friday with a price-earnings ratio of 53.94, a price-book ratio of 1.06 and a price-sales ratio of 1.46.
The Peter Lynch chart shows the stock is trading above its fair value, suggesting it is overpriced.
Parco's financial strength was rated 4 out of 10 by GuruFocus. In addition to having poor interest coverage, the Altman Z-Score of 0.77 warns the company could be at risk of going bankrupt.
The company's profitability fared a bit better, scoring a 6 out of 10 rating on the back of an expanding operating margin and a moderate Piotroski F-Score of 4, which indicates business conditions are stable. Since Parco's revenue per share has been in decline over the last five years, the business predictability rank of one out of five stars is on watch. According to GuruFocus, companies with this rank typically see their stocks gain an average of 1.1% per annum over a 10-year period.
Hennessy holds 0.12% of the company's outstanding shares.
Tokyo Ohka Kogyo
The fund picked up 25,100 shares of Tokyo Ohka Kogyo, giving it 0.63% space in the equity portfolio. Shares traded for an average price of 3,336.73 yen during the quarter.
The company, which manufactures functional materials and processing equipment used in creating semiconductors and liquid crystal display products, has a market cap of 176.24 billion yen; its shares closed at 4,265 yen on Friday with a price-earnings ratio of 26.84, a price-book ratio of 1.22 and a price-sales ratio of 1.71.
According to the Peter Lynch chart, the stock is overvalued.
GuruFocus rated Tokyo Ohka Kogyo's financial strength 8 out of 10 on the back of adequate interest coverage and a robust Altman Z-Score of 5.16.
The company's profitability and growth scored a 7 out of 10 rating. Although the operating margin is in decline, it still outperforms over half of its industry peers. While Tokyo Ohka Kogyo has moderate returns, its Piotroski F-Score is a low 3, which suggests poor business conditions. The one-star business predictability rank is on watch as a result of declining revenue per share over the last 12 months.
The Japan Small Cap Fund holds 0.06% of the company's outstanding shares.
Having previously exited a position in Towa in the fourth quarter of 2017, the fund entered a new 94,300-share holding. The trade had an impact of 0.55% on the equity portfolio. During the quarter, the stock traded for an average per-share price of 806.02 yen.
The company, which provides semiconductor molding equipment, has a market cap of 23.03 billion yen; its shares closed at 953 yen on Friday with a price-book ratio of 0.87 and a price-sales ratio of 0.91.
Based on the median price-sales chart, the stock is trading near its historical average.
Towa's financial strength was rated 5 out of 10 by GuruFocus. The Altman Z-Score of 2.26 suggests the company is under some financial pressure.
The company's profitability and growth fared much better, scoring a 7 out of 10 rating on the back of an expanding operating margin. Towa is being weighed down, however, by negative returns that underperform a majority of competitors, a low Piotroski F-Score of 3 and a one-star business predictability rank that is on watch as a result of declining revenue per share over the past year.
Hennessy holds 0.38% of the company's outstanding shares.
Additional trades and portfolio performance
During the quarter, the fund managers also established positions in Studio Atao Co. Ltd. (TSE:3550), Kushikatsu Tanaka Holdings Co. (TSE:3547) and Starzen Co. Ltd. (TSE:8043).
The Japan Small Cap Fund's $135 million equity portfolio, which is composed of 60 stocks, is heavily invested in the industrials sector, followed by technology and consumer cyclical.
According to its fact sheet, the fund posted a return of -12.51% in 2018, outperforming the Russell/Nomura Small Cap Index's -18.12% return and the Tokyo Stock Price index, which returned -14.30%.
Disclosure: No positions.
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This article first appeared on GuruFocus.