´´ Cheap Stocks in Japan - Discrimination in Selecting Japanese Net-Net Stocks

Thursday, December 6, 2012

Cheap Stocks in Japan - Discrimination in Selecting Japanese Net-Net Stocks

Many people bemoan that for years their screens have been coming up with the same Japanese net-net stocks. Therefore they come to the conclusion that it's not worth buying into Japanese net-net stocks at all, as they will very likely remain net-net stocks forever or will eventually go bust.

This conclusion might hold true for a bulk of those issues selling below liquidation value (especially constantly money losing securities). But the net-net sphere in Japan is extraordinarily diverse (as it is the stock market in general in Japan).

Cheap Japanese Stocks: Graham and Dodd Net- Net Stocks

On one end you'll find money losing issues, which have been eating in their net current asset value year after year, thus still living their dire existence on the Japanese exchanges. On the other end of the scale, diligent investors will find net-net stocks that have been even prospering in terms of sales and (retained) surplus, provided they tracked those stocks over a slightly longer period of time, e.g. 7 - 10 years. Between these extremes there are hundreds of net-net stocks to be found that come in different flavors. Those issues might be the most challenging ones for the interested investor, given the limited resources available and the need of adroit distribution.

This post is about the latter bunch of net-net issues to be found on Japan's security exchanges. The intention is to give the interested investor a hand about how to weed the most promising net-net stocks out of those with less favorable statistical readings.

Firstly, let us revise what my Gurus Graham and Dodd have to say regarding that problem.

Graham and Dodd deal with that subject in chapter XLIII at page 498 ff. of the first edition of security analysis.

" (...) the phenomenon of 1932 was the direct outgrowth of the new-era doctrine which transferred all the tests  to the income account and completely ignored the balance- sheet (...)"

"There is scarcely any doubt that common stock selling well below liquidating value represent on the whole a class of undervalued securities (...) declined in price so severely than the actual conditions justify...must mean that on the whole these stocks afford profitable opportunities for purchase."

"Nevertheless, the securities analyst should exercise as much discrimination  as possible in the choice of issues falling within this category (...) he will be partial to such (...) reveal other attractive statistical features besides their liquid asset position, e.g. satisfactory current earnings and dividends, or a high average earning power in the past."

"The analyst will avoid issues which have been losing their quick assets at a rapid rate and show no definite signs of ceasing to do so."

Two Japanese Net- Net Stocks Compared

 (Thanks to spike, from spike japan, who tried to encourage me to proceed with my resarch of undervalued stocks in Japan, and unselfishly came up to suggest me this marvelous net-net (irony!!!))

In 2009 Noritsu's share traded at a discount of roughly 50% to its NCAV. Since up to now this discount has even widened to 70%, because the stock price has plunged during that period another 50%+. Is this market level a streaming buy? Maybe. It is quite likely that selling in this stock has been taken way too far and the stock is about to recover significantly. Why am I not inclined to buy into this stock than? Quite frankly, I don't like the current asset trend.

Current assets declined by roughly 37% and cash assets by 31%. The decline in net current assets, with a showing of 33%, was not as strong as that of the current assets, due to the favorable trend in current liabilities, e.g. the reduction of current liabilities.

Let’s have a look to Noritsu's recent earnings trend.

Well, that's just appalling and confirms what has been derived from the current asset trend.
The earning trend (or better loss trend) drained a lot of valuable resources out of the company's current assets.

Let us compare Noritsu's liquid asset development to another net-net stock.

Ryoden's discount to current asset stands roughly at 77%, the discount to net- current assets is approx. 50% and that to net-net current assets 45%

Ryoden's discount to net- current assets is not as steep as that of  Noritsu.
But in contrast to Noritsu, Ryoden was able to increase its current asset position by 25% and its cash position by 20%. Unfortunately Ryoden increased its current liabilities, so its net-current asset position only increased by roughly 7%. That negates to some extent the encouraging trend in its current asset position.

Let us now turn our attention to Ryoden's earning trend.

Ryoden's earning trend, though not spectecular, nevertheless is much more comforting. Although profit margins are annoyingly low, stock price has fallen to such an extent, that Ryoden's average P/E stands at 11,3 and the actual reading is just shy of 10 times earning.

Interim Conclusion:

Given the current asset trend (in combination with the trend in earnings) the intelligent investor would come to the conclusion that Ryoden should definitely be favored over Noritsu.

But that does not mean that a speculative position in the issue of Noritsu could not be rewarding. It could well indeed be very rewarding, in spite of the unfavorable trend in current assets and earnings. Given the deep discount of current market price to the stock's intrinsic value, this stock could spice up a diversified Japanese net-net portfolio.

Only should the investor always keep in mind the more speculative nature of the position he is taking with Noritsu, as the risk of bankruptcy is higher.

Net- Net Stocks in Japan: Ryoden vs. Ryoyo

Let us now introduce a third net-net stock and turn our attention to a little more challenging case of comparative valuation. Why is it more challenging?

1.) It concerns a comparative analysis of two companies that operate( in great measure) in the same business field

2.) Both companies are profitable

In short, the case is not as clear cut as the first, hence much more ambiguous.

This time the starting point of the comparative analysis is the income statement.

Most striking is Ryoyo's decline in sales (-24%) compared to an increase of 6% in Ryoden's showings.

What I personally find interesting is, that both companies show roughly the same net income margins, independently of their very distinct aberration in revenue trends.

Anyway, on an operational trend basis there is no question that Ryoden should be favored over Ryoyo.

Let us now turn our attention to the current asset trends of both companies.

Ryoyo's discount of market price to current assets stands at roughly 59% compared to Ryoden's 77%. On this metric Ryoden is to be preferred. But on a net-current asset basis Ryoden's discount shrinks substantially to only 50%, roughly matching that of Ryoyo (51%). Ryoyo is catching up!

What are the comparative readings of the discount to net-net current assets (=current assets - all liabilities)? First place for Ryoyo with approximately 50%. Second place Ryoden with roughly 45%.

What is the reason of Ryoyo's better discount readings in net-net current asset? It is to be found in its lesser indebtedness, e.g. better showings in current liabilities as well as overall liabilities.

What about the trend in its current assets? Actually Ryoyo's current assets has been shrinking by roughly 8%, whereas Ryoden's current asset position improved by 20% over the same time span. Also in the comparative analysis of the trend in cash assets, Ryoden appears to fare better (20% vs. 2%). On a gross basis it seems that Ryoden has done substantially better in the current asset trend than has Ryoyo. But having said that, one has to take into account, that Ryoyo shrank its current liabilities by around 26%. Whereas Ryoden increased its current liabilities by 45%.

More importantly, between 2010 and 2011 Ryoyo bought back a significant amount of its own shares and retired them, while Ryoden didn't do anything in that respect. This share buyback brings forth a significant better cash trend reading on a per share basis in Ryoyo's case (11% compared to 2% on a nominal basis). Quite a difference.

Furthermore, Ryoyo's overall current asset composition is much more favorable than that of Ryoden, with cash and equivalents representing the biggest chunk, followed tightly by receivables. Inventories only represent approximately 20%. In contrast Ryoden carries more inventory than cash on its current asset balance and receivables represent by far the biggest blog.


Firstly, on an operational trend basis Ryoden is definitely to be preferred over Ryoyo, given its superior showing in sales and earnings trends.

Secondly, although the current asset trend favors Ryoden over Ryoyo on a gross basis, on a net basis one has to come to the conclusion that Ryoyo is showing the superior readings.

Thirdly, Ryoyo's current asset composition is superior to Ryoden's, thus Ryoyo's liquidation value is much higher (actually Ryoden is trading at a premium to liquidation value).

Furthermore, Ryoyo bought back a significant amount of its shares (approx. 8%) and retired those shares. Thus, Ryoyo's cash holding per share is 3 times higher than that of Ryoden.

Finally, Ryoyo has got an investment portfolio of roughly 400 yen/ per share (compared to 160 yen per share for Ryoden). As it is highly likely that the great majority of those investment holdings are in marketable and liquid assets, they should be added to the liquidation value. Therefore Ryoyo's liquidation value stands at 1640 yen per share and the stock is trading at a discount of roughly 50% to it. Whereas Ryoden currently trading at a premium to its liquidation value.


  1. Hi,
    I am a private investor trying to enter the japanese market - a fairly difficult one to my understanding in the past decades - and was very happy to read your recent article as an introduction.
    I hope you held the first two shares since Mr Market seems to recognize some more value in them only 6 weeks later, 1/3 more for Noritsu Koki and 1/4 for Ryoden Trading. Ryoyo remained at a similar price and maybe because of that attracts me more.
    Now one question related to your topic : is there a - free? - database or screener, in English, which can help sort out some of the interesting Japanese companies (in the Graham and Dodd sense) ?
    And another question related to the Japanese market : would you know how to access the fixed income Japanese market, especially the corporate bonds when you don't hold any account in Japan ?

    1. Hi Alf,

      having hold on to all of my japan stocks.

      I don't do any screening, as it is too "mechanic" for me. Many interesting stocks you would have missed with screens. For example Hogy medical or Fukuda Denshi, as they weren't net-nets.

      But FT.com does offer a screener.

      "And another question related to the Japanese market : would you know how to access the fixed income Japanese market, especially the corporate bonds when you don't hold any account in Japan ?"

      Sorry. I haven't got a clue, as I only do stocks. Stocks like Ryoyo are basically valued like a bond. And the offer you a better dividend!

      Read the post again! I don't hold Noritsu or Ryoden. I hold Ryoyo!



  2. Hi / Hallo O-tone,

    Thank you for your fast answer, and I shall certainly read your post again to check the points I missed.

    Still your answer left me curious about how your are selecting your stocks. If you don't speak Japanese, you have to limit yourself to the companies publishing in English. This is a first screen.

    And then you just go fishing like Ben Graham did as a young man, or Buffett 20 years later ? Going through all the listings of the Japanese stock market and choosing company by company ?

    Or maybe you are working / living in Japan and that helps ? Please understand that those are not personal questions but just me looking for one or two keys to know better and to enter the Japanese market.

    I am going through most of your blog and find it quite interesting. I may come back to comment, or rather to approve one or two of your views on Japan. Even though I went there some 10 years ago, I am by no way a specialist of Japan.



    1. Hi Alf,

      "you have to limit yourself to the companies publishing in English. This is a first screen."

      That is correct.

      I am more inclined to the Graham style than to the buffet style. Although I take into account qualitive issues, e.g coproate governance.

      Some I've found by chance (going through the market company by company). Some are "stolen ideas", holdings by other fund managers or mentioned on other value investing blogs.

      "I may come back to comment, or rather to approve one or two of your views on Japan"

      Always do your own due dilligence! Do the tideous work of financial analysis! Also watch out the liquidity of the stocks! Many net-nets in Japan are very illiquid.


  3. Well thank you for that and I shall keep in touch with your blog, I left my email in order to follow it.


  4. Very informative website. I read the Security Analysis and currently invest in Japanese net nets as well. So far it has been a profitable experience.

    Here are some of the net nets that have been increasing in NCAV:
    1) Avelco
    2) Mushahi Co
    3) Fuji Oozx
    4) Odawara Engineering
    5) Systems Design

    It just amazes me that the market is valuing them at ridiculous prices, with some even below liquidation value.