Japanese stocks have shot up 75% and then tanked 20%. So are they cheap? Ignoring PE TTM the answer appears to be yes. First, look at Market Cap to GDP, which is Warren Buffett’s favorite metric. One of the most interesting aspects about the chart is that every single market is at a far higher valuation today than in 1989 bar Japan. See more on this chart here. Below is some more data on this topic from a new note via Chisato Haganuma, Chief Equity Strategist, Mitsubishi UFJ.
think recent volatility in Japanese stocks cannot be fully explained by expectations regarding Japan’s economy and earnings and BoJ/Fed monetary policy. We think investors seeking short-term gains are also playing a part in volatility. We should also not discount the effect of a lack of reliable valuations, which we believe means an equities rally tends to breed optimism, while a market decline breeds pessimism. In this report, we provide a basic analysis of what we believe is fair value for Japanese shares.
Japanese Stocks do not look overvalued from a macro perspective
We think it is useful to compare the value of the stock market against the size of the macro economy. Japan’s total market cap (TSE1, TSE2, and JASDAQ) stood at ¥381trn on June 13, which is 24.6% of total personal financial asset holdings (Figure 1-1). This ratio is below the 26.9% average since 1992, and has fallen from 29.9% on May 22 (when market cap was ¥463trn). Market cap is 80.1% of nominal GDP, which is above the 73.5% average since 1992. In the US, market cap (total of NYSE and NASDAQ) represents 37.5% of personal financial assets and 135.3% of nominal GDP.
Majority of Japanese stocks TSE1 trading below 1x P/B
At an individual company level, stocks trading below P/B of 1x on June 13 represented 40.6% of TOPIX 500 and 56.0% of TSE1. Both ratios are above the average since 1998, in the midst of Japan’s financial crisis. (First Eagle notes Despite the steep year-to-date increases in share prices, based on book value, the market may still appear cheap. Half of all Japanese stocks trade below book value. This is comparable to Greece. In the United States, only 12% of companies trade at such a low figure.
Japan’s P/Es not high if we factor in sector weightings
Financial market globalization makes comparisons between Japan and other markets increasingly relevant, in our view. A growing number of overseas asset managers are allocating global funds to Japanese equities. However, many market observers still regard Japanese equities as overvalued in P/E terms compared to European stocks. Based on MSCI data, both US and Japanese stocks were trading at a P/E of 15.1x FY13 EPS estimates, vs. 12.8x for European stocks, as at June 7 (data compiled by Factset; Figure 1-2). However, P/Es are affected by the weighting of individual sectors. For example, compared to Europe, Japan’s consumer discretionary and IT sectors have a higher weighting and energy and health care sectors have a lower weighting (Figure 1-3). IT sector P/Es are 17.0x in Japan and 20.4x in Europe, and energy sector P/Es are 8.4x in Japan and 9.1x in Europe. In energy and resources, we think P/Es have been low because of increased industry investment and speculation about commodity price declines over the last few years. On the other hand, we think Japanese electric power companies are pushing up the market’s overall P/E because they are expected to make further losses in FY13. If we take into account the different weightings of each sector in Japan versus other markets, we do not think Japanese stocks are overvalued.
FY13E EPS puts TOPIX fair value at 1,110
We believe the average long-term P/E on US stocks can be a useful yardstick for ascertaining what constitutes fair value P/E over the medium term, from a global perspective. According to Yale University Professor Robert Shiller, the average P/E for S&P 500 stocks since the 1880s is 15.3x (see our equity strategy report, “What is the fair value of Japanese stocks?”, dated March 22). In Japan, the all-industry (excluding financials) forecast for FY13 calls for 23.7% growth in RP and 64.0% growth in NP, which puts TOPIX EPS at around ¥74 (based on Toyo Keizai forecasts). Using a fair value P/E of around 15x, this EPS forecast puts TOPIX fair value at around 1,110.
We also think earnings forecasts play a key role in determining fair value. FY13 RP forecasts continue to be revised upward, mainly because of changes to forex assumptions (Figure 1-4, as at June 13). We believe Japanese companies are improving their earnings structure by keeping costs down and expanding overseas ops. We think awareness of shareholder value is starting to build, as companies focus more on shareholder returns and more companies appoint external directors. While it seems somewhat of a paradox, we still see substantial room for improvement in earnings in Japan because of the number of companies with relatively low capital efficiency.