A Value Investor’s Haven: Investing in Japan [Part III]

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A Value Investor’s Haven: Investing in Japan [Part 3] by SG Value Investor, The Value Edge

Having explained the characteristics of the Japanese market in Part 2, I would be sharing how one, or rather how I navigated myself through the Japanese market.

Looking at the Japanese market, the biggest problem I faced was, there are so many Japanese net-nets. Hence, how was I supposed to know which one should I invest in? Do I purchase the one with the lowest Price-to-Earnings ratio, biggest discount to NCAV, lowest Price-to-Book ratio etc. With such overwhelming number of cheap companies, I experienced analysis paralysis.

Templeton, a committed contrarian, believed the only way to get a bargain in the stock market was to buy when everyone else was selling: At the outbreak of World War II, when everyone else was panicking, he bought shares in every NYSE-listed company that was trading for less than $1–and made money on nearly all of them. He was early to see the benefits of diversifying outside of America; international investing became his signature style. It worked : $10,000 invested in his flagship fund in 1954 grew into $2 million by the time Templeton retired in 1992.

Forbes, June 30, 2014

Essentially, like Templeton, I came up with a simple list of criteria to decide upon which stocks makes the cut, followed by choosing those with a comfortable margin of safety. To be honest, margin of safety wouldn’t be the main concern with such stocks. Given that they are trading nearly 50% discount to NCAV, they are truly worth more dead than alive. However, the surprising thing with these companies would be that the chances of them liquidating and going belly up is really slim. A research done by Montier, suggests that net-nets are liquidated in only around one-in-twenty cases, translating to a 5% chance. Another point to note would be that whilst I use terms NCAV and liquidation value interchangeably, a liquidation analysis is really just a theoretical exercise in valuation, but not an actual approach towards valuation. The assets of a company are usually worth more as part of a going concern than in liquidation.

  1. Stable Company. David Merkel of the Aleph Blog wrote an analogy once, discussing two types of stability – table stability and bicycle stability. Essentially, a bicycle is stable as long as it keeps on moving forward. While a table is stable at rest, however, there is no movement. Well with net-nets, it is the same story. Essentially you want to find a company that exhibits table stability. These companies normally have problems such as lacklustre in operations, but you want a company that has a balance sheet that can support such operations in the long run.
  2. No Debt. Like the point mentioned above, only a company having little or no debt would be able to survive in the long run.
  3. Share Repurchases. While I am not expecting the management of the company to be constantly buying back shares, it would be good to note that over the span of the last 10 financial years, the management is actually buying back shares. This not only increases existing shareholder’s value but it increases the confidence shareholders have with the company. Business managers are the ones who understands the business the best. During periods where management decides to buyback shares, more often than not, it is because they know that current market prices does not reflect the true worth of the company.
  4. Pays a dividend. To me what matters the most is not the dividend yield but that management actually distributes a portion of earnings back as dividends. Moreover, research has shown that companies that pay dividends tend outperform companies that do not.
  5. Positive EBIT/Net Income/FCF. I tend to look at the past 5 to 10 years of the company’s financials and look at their EBIT, Net Income and FCF. Choosing companies with positive EBIT/Net Income/FCF is roughly the idea. However, I am not too strict about this, especially with FCF. A company having negative FCF may not be a bad thing. For example, they may just be suffering a period of low FCF because they increased Capital Expenditure significantly (look at the case of BreadTalk).

I have come to the end of my 3-part research on Japan and have been coming up with a list of approximately 6 to 8 companies to invest in. To be honest, research can only take one so far. From all the case studies and backtests I have read, this is all that I share. Going forward, only time would tell how well such a strategy would work out and it truly is a test of conviction and focus.

With this, I hope to reach out to other value investors out there who have invested in the Japanese market or have any other valuable insights to add.

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