Japanese Value. Japan typically isn’ t the region you would associate with expensive equities but according to…
Japanese Value – more gains ahead?
Japan typically isn’ t the region you would associate with expensive equities, but according to CLSA strategist Nicholas Smith, there seems to be a g rowing chorus among investors that the Japanese market, having gained 12% since the start of 2017, is now too expensive.
However, Mr. Smith argues that the market as a whole is not that expensive, but the most in-demand stocks, particularly low volatility equities, pricey compared to historic multiples.
Specifically, Smith opines:
Japan’s Topix is cheap: on PE; on EV/Ebitda and the number of companies on negative EV; on cashflow; and on book and the percentage of stocks trading below that book. And essentially all of that book is tangible, stuff you-can-stub-your-toe-on book.
The rest of the market looks cheap as a whole. Where the US stock market is trading on a price to tangible book ratio of 8.7x, the benchmark Topix is trading at a cheap 1.5x, making it a value investor’s paradise.
One reason for the disconnect is company efficiency. Mr. Smith notes in a report issued earlier this week that most US companies have offloaded non-essential assets, becoming exceptionally lean and using the proceeds to buy back stock. In comparison, Japanese companies are still “bloated” with excess capital.
Unfortunately, in recent years value investing in Japan has been a difficult business. In the run-up to the financial crisis, Japanese value stocks consistently outperformed but following the crisis, value’s run of underperformance is the deepest on record. The same scenario has played out in other major world markets. Investors have flocked to low volatility and growth equities, avoiding value and more cyclical businesses. As Mr. Smith notes, value underperforms in times of low growth; low inflation and low yield, which is exactly what the world has been suffering from during the past decade.
Still, there are some signs that value’s hostile environment is improving. The global manufacturing purchasing managers’ index bottomed out in February 2016, and so did equity markets such as the Topix and S&P. Meanwhile, the Japanese labor market is one of the healthiest in the world with labor cash earnings growth hitting 0.5% year-on-year in April, and the ratio of job openings to applicants stands at 1.48, the highest in 43 years.
Aside from macro factors, the most significant recent development that could boost the performance of Japanese value is the move by key investors to reveal how they vote at company shareholder meetings. According to the Financial Times, these actions, where large pension investors and fund managers vote on issues such as pay, board membership and Chief Executive tenure should “help end the often-cozy relationships between investors and companies in Japan.”
This, in turn, should prompt companies to change themselves or face scrutiny from the public and policymakers. Companies that do not generate attractive returns for shareholders will likely be called out for pursuing non-growth policies, and it’s more likely cozy managements will be held accountable for their actions. Shareholder disdain may quickly translate into increased activity by management to unlock value for investors.
