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We’ve looked at Japan a couple of times over the past month. The country’s stock market has also attracted more media attention in 2023, probably because of the wave of fawning press that follows Warren Buffett wherever he goes.
More bullish sentiment is partly being driven by efforts to improve valuations and corporate governance in the country. A couple of examples of these should give readers an idea as to why that’s the case.
First, last year the Tokyo Stock Exchange (TSE) changed how companies are segmented. Those changes mean that listed companies are now segmented as ‘Prime’, ‘Standard’ or ‘Growth’.
The most significant component here from investors’ point of view is the fact that a company must have a certain proportion of tradeable shares to be in the Prime category. However, shares held by Japanese banks, insurers, and corporates, as well as ‘interested parties’, which includes relatives of directors or companies that directors control, are not counted as tradeable shares.
The idea here is to push firms to stop having cross shareholdings, something that has long been a source of consternation for investors in Japan and which creates obvious corporate governance problems.
Another key change introduced by the TSE last year was to encourage firms to improve their price to book ratios. It seems bizarre that an exchange is having to enact these policies, but firms that consistently have a P/B ratio below 1 have to lay out a plan as to how they will work to improve their valuation.
These two changes provide a clear investment driver for Japanese equities. Firms will be forced to improve corporate governance if they want a premium listing. They will also be pressured into taking steps to increase their valuation.
With regard to the latter, the simplest solution for companies is to initiate buybacks or start paying out more in dividends to shareholders. This presents an almost too obvious set up for value investors. You look at companies trading below book and then wait for them to initiate some kind of turnaround programme.
There are some examples of companies that have benefitted from this dynamic in the Schroder Japan (SJG) portfolio. For example, insurer Tokio Marine has seen a substantial increase in its share price over the past five years because of a set of changes that have lifted its book value.
The problem with this is the potential that you can end up in a value trap. A buyback programme and commensurate increase in valuation has a kind of mechanical logic to it. You buy, the buyback (or similar) programme is enacted, there is an uplift to valuation. But even if we assume that process actually plays out, then what? Getting access to dormant cash holdings is one thing, holding for the long term is another.
This also means thinking of Japanese companies as a pure value play and, although there are certainly a lot of interesting opportunities in this regard, there are lots of innovative companies in the country as well.
This can seem counterintuitive given the narrative that Japan has a shrinking economy and well-known demographic problems. But to build on a point one of my colleagues made recently about pithy comments, even if this is true, it is hard to square it with the claim that the stock market is not the economy.
Take messaging app Line as an example. The company was founded in 2011 as a way for people to communicate after an earthquake struck Japan. Today it is active across multiple sectors, including e-commerce, financial services, and ride hailing. Revenues have grown from $80m to over $2bn in a decade.
Line is owned by Softbank Corp, which is a major holding in several Japan-focused trusts. But it’s also a good example of how Japanese companies can still be innovative and deliver exceptional growth.
Lindsell Train (LTL) provides another glimpse of this. The trust has long held video game company Nintendo as a top 10 holding. Nerds may disagree but Nintendo has few peers globally and is arguably the most innovative company in its sector today. That Microsoft was eager to acquire the video game company in 2020 is a sign of that.
And as with Line, it’s indicative of the fact that Japan has both value and growth stories to offer. Investors may benefit from short-term bumps that boosts to return on equity provide. But there are plenty of reasons to hold for the long term as well.
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