A Value Investor’s Haven: Investing In Japan [Part II] by SG Value investor, The Value Edge
Having explained the mindset one should adopt when entering the Japanese market in Part 1, I would be sharing the characteristics of the Japanese market in this post.
One thing I have learnt, when entering a new market, would be definitely to do your ground work. While one investing strategy may work in one country, it does not mean it would work for every. Broadly speaking, it is still the same process of finding stocks having cheap earnings multiples, low price-to-book ratios, quality management, solid & stable business. However, certain tweaks are needed for each market. Even with other forms of investing, say algorithmic trading, the algorithms used have to change in a different market. Whilst this list is by no means exhaustive, I will be sharing some of the key traits that I have identified.
Characteristics of the Japanese Market:
- Average Price-to-Book ratio. Valuations in Japan looks undemanding with an average price-to-book ratio of 1.2x compared to other developed markets like Europe and USA trading at 1.8x and 2.2x. Looking more in-depth more than 60% of Japanese companies are trading below book value. Such low multiples can be explained by the margins. Japanese companies suffer structurally due to their lower returns on equity, which is in the low single digits.
- Hoarding of Cash. Many liken Japanese companies to Japan, a country that is broke and stagnating. However, the truth is very different. While the Japanese government is heavily in debt, Japanese companies are paradoxically in much better shape. Most companies have spent the last 20 years repairing their balance sheets, paying down debt and hoarding cash. This partly explains the reason for the low return on equity or assets ratios in Japan.
- Share Repurchases. One thing I realized with most companies I have been screening would be that share repurchases is a big thing. Many of the companies that I have been screening would display number of outstanding shares decreasing, where management is constantly buying back shares.
- Investment Securities. Using a net-net approach, it would disregard investment securities as it would be listed under non-current assets. However, if one were to think about it, marketable securities are something easily converted to cash. Hence, in some ways, it can be taken as a form of cash and added when calculating for NCAV. When screening, I find gems that are trading at 50% to NCAV and this this NCAV has yet to include marketable securities. Furthermore, it is quite common to find companies holding marketable securities on their balance sheets as well. Therefore, while on the surface it may seem that the company is trading at say 50% to NCAV, in actual fact is is much more.
- Japanese Culture. When using a net-net approach, one is heavily reliant on the numbers. This is especially so with Japan as most Annual Reports and Company Websites are in Japanese, essentially, we are flying blind and this blindfold is not something that is going to come off anytime soon. However, what puts me at ease with using a net-net approach in Japan would be the Japanese culture. Having been to Japan many times, especially once more this summer, the culture of the people is extremely important when it comes to investing in my opinion – and the thing about culture is that it can’t be simply learnt from textbooks but require the physical human interaction. I find the Japanese, people who highly values qualities like integrity, honor and reputation. With such qualities, cases of accounting fraud is pretty rare. Truth be told, I feel more reassured investing in the Japanese market as compared to the Hong Kong market, with the huge number of H-shares.
In part 3 of this series, I would be sharing my strategy with regards to entering the Japanese market.