Why Warren Buffett's Berkshire Hathaway has a $7 billion bet on 5 Japanese stocks

• Warren Buffett's Berkshire Hathaway revealed 5% stakes in five Japanese trading houses on Sunday.
• The positions in Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo were worth a combined $6.9 billion as of Wednesday's close.
• The billionaire investor was likely attracted by their depressed valuations and sprawling operations, and may have seen them as hedges against inflation risk and US dollar weakness.
• Here are six reasons why Buffett may have invested.
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Warren Buffett's Berkshire Hathaway recently disclosed that it owns 5% of each of Japan's five biggest trading companies or "sogo shosha": Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo. The positions, which Berkshire built over the past 12 months, were worth a combined $6.9 billion as of Wednesday's close.

The famed investor may have backed the businesses because of their cheap valuations and varied operations, as well as the macroeconomic environment.

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Here are six potential reasons why Buffett is betting on the Japanese quintet:

1. Bargain prices

Buffett is renowned for identifying and investing in businesses that are undervalued by the market. He lived up to his reputation with the five Japanese trading houses, as four of them trade at a significant discount to book value, meaning their market capitalizations are lower than their net assets.

The investor may have turned to Japan after struggling to unearth value on home soil. Stocks were far from a bargain this time last year, when Buffett began building the Japanese stakes, and have rebounded from the coronavirus crash in record time, thanks to unprecedented interventions by the US government and Federal Reserve.

Buffett invested in the Japanese companies at "laughably low" prices, highlighting the "tremendous" value on offer in the island nation, Dalton Investments chief Jamie Rosenwald told Reuters.

2. Low risk

Buffett may be investing in a foreign country, but he's deeply familiar with what the five trading houses do. They could be described as mini-Berkshires, as they're conglomerates focused on traditional industries such as natural resources and shipping and have business interests around the world.

The Japanese quintet are also firmly established, generate plenty of cash, boast competitive moats to fend off rivals, and several pay sizeable dividends, Jefferies Japan analyst Thanh Ha Pham told Bloomberg.

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Japanese companies are also known for their honest accounting, making the nation a "natural fit" for Buffett, Pham said in another Bloomberg story.

The five firms offer a "winning combination" of global operations and "fingers in a lot of pies at an attractive price," James Armstrong, president of Henry H Armstrong Associates, told Reuters.

3. Teaming up

Buffett appears to see the Japanese companies as not just investments, but also potential partners for Berkshire's subsidiaries.

The investor highlighted the quintet's many joint ventures around the world in his statement on Sunday, and expressed hope that "opportunities of mutual benefit" will emerge.

4. Preparing for inflation

Inflation fears are rising as governments and central banks continue trying to spend their way out of the coronavirus crisis. Their efforts so far include mailing out stimulus checks, bailing out distressed companies such as airlines and cruise lines, and plowing trillions of dollars into financial markets.

Central bankers have also slashed interest rates to almost zero, and Federal Reserve chief Jerome Powell said last week that inflation will be allowed to rise above the bank's previous 2% annual target for periods of time.

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Buffett may be betting on higher prices with his Japanese investments, Bill Smead, boss of Smead Capital Management, told Reuters.

"Buffett is migrating his investment to where you can create value through inflation," he said. "These are companies that will make more money if the price of oil [or] any input goes up."

5. Dollar drop

Worries about the pandemic's brutal fallout and stimulus deadlock have driven the US dollar to a two-year low, and a stronger Japanese yen means bigger profits for many Japanese companies.

Buffett may have anticipated a US dollar decline and turned to Japan to diversify his currency exposure. Indeed, Berkshire sold 430 billion yen ($4 billion) worth of bonds last September — the biggest yen-denominated bond sale by a non-Japanese issuer in history.

It sold another 195.5 billion yen ($1.8 billion) of bonds in April, meaning it has a total 625.5 billion of yen-denominated bonds outstanding. Berkshire cited that figure on Sunday as the reason it has "minor exposure to yen/dollar movements."

6. Cash to burn

Buffett is constantly looking for ways to responsibly spend Berkshire's massive cash pile, which totaled $147 billion at the last count. His disclosure of the Japanese bets follows a flurry of purchases in recent weeks.

For example, Berkshire struck a $10 billion deal to buy Dominion Energy's natural-gas assets in July, plowed close to $2.1 billion into Bank of America stock in the 12 days to August 4, and appears to have repurchased more than $7 billion of its own stock between May and July.

Buffett may have simply bought the Japanese stocks because he had the cash to spare and they met his investment criteria.