Japan - A value Investor's Dream

First of all I would like to thank Ryoji Musha and Junko Matsuda from Musha Research for allowing me to use their excellent charts on this blog. Among other things, the people at Musha Research have been doing a great job in scrutinizing the so called "lost decades" of Japan and presenting a "truer" picture of Japan's economic state of affairs.

I highly recommend to read the insightful articles of Musha Research. It is very encouraging to see other economists and japan observers debating the japan scaremongers and doomsayers. Especially as there are so few!

 Link to Musha Research

http://www.musha.co.jp/index_en 

The Thousand Autumns of a Value Investor

As an deep value investor one is constantly searching for the famous dollar for fifty cents. You screen hundreds of companies, quantify their net liquid asset position and scrutinize the past trend in operations and cash generation. It is a lot of tedious work, especially considering the amount of discard involved in the analytical process. Basically, as a value investor one is in the rejecting business. The company has been eating into their current asset position through losses, current asset composition is unfavorable, the company is carrying too much debt, the cash flow is too volatile, etc. Personally speaking I think the amount of analytical discard is the most arduous part of applying the concept of value investing. Most of the time you fell like wasting your precious time.

But suddenly, almost always you are about to give up, the value beauty emerges.

A net- net stock with mouthwatering ratios of EV/ Ebitda < 3, combined with an operational history of not having generated a loss year in the last 10+ years. Cash- Flow positive and even having been generating free cash- flow and paying a dividend, etc.  Or even better a company with negative Enterprise Value (EV) that is and has been profitable. Virtually, Mr. Market is paying you for getting your hands on a partial ownership of a viable business. Bingo! Such discoveries are the exhilarating part of the value investing business. Finding stocks like this gives me a real push and motivates me for the pending work, e.g. digging into the P&L, cash flow statements, footnotes for adjusting the stated numbers in order to come up with the true asset value and earning power of the company and its intrinsic value.

During the process of adjusting the numbers of such a value beauty the first excitement usually abates rather quickly (although the numbers are fantastic), because the one question starts to come into my mind: Why is this stock so cheap? This moment is very sobering. I hate it, as it gets me closer to the rejection cycle again, which is so tiring in this job. But it is a legitimate and important question and has to be asked and answered. Especially when keeping in mind the saying of a famous investor: "If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy"

Topics surrounding the "Why is it cheap?" question involves mainly qualitative issues like corporate governance, moat, competition, pending litigations or upcoming litigations, etc. Or even worse, is this "beauty" you have just dug out a fraud? Those questions are extremely hard to answer. But one has to come to a more or less qualified opinion anyway in order to execute on the investing idea with enough conviction. Without an opinion about the reason for the cheapness of the stock, it is hard to hold on to your position when Mr. Market is gripped by its depression.

Corporate Japan: Why are you on Sale?

Concerning value investing in Japan there is a peculiarity to be observed here. Unlike other major economies Japan is trading at extremely depressed asset values. The stated PBR (Price- book Ratio) stands at a paltry 1,2, only undercut by Italy with 0,9. The ratio of 1,2 does not take into account all the hidden assets corporate Japan has been allowed to built up during the mythical "two lost decades". And believe me, in many cases those hidden reserves are more than significant. In all likelihood corporate Japan is still trading roughly at or even below adjusted book values. And that is even after the roughly +60% Abenomics melt up in the Nikkei. In short: Japan still is a stock pickers dream!

So also in the case of the overall stock market and especially in the case of Japan, which has been trading at those depressed asset values for such a prolonged period of time, the aforementioned question has to be asked: Why is the stock market in Japan so cheap?

Unfortunately, also here the question has to be (at least partially) answered by the interested value investor. Mainly in order to act with satisfactorily conviction on the discrepancy between price and value.

Fortunately, in the case of Japan it is a pretty easy task to come up with a satisfactory and convincing answers.

Yes dear investors. Brokers don't call you up when bargain issues are all over the marketplace. They do prefer to take a little nap (although in the case of Japan it seems rather like a permanent hibernation).

But not only do the brokers in Japan prefer a little time out during the bottoming out of the most severe bear market modern history has seen. So do the sell side analysts. Even an emerging market like South Africa is covered more broadly than the third biggest economy on this planet. Ludicrous!

Japan – Still A Stockpicker's Dream  (PDF File)

While local brokers and sell side analysts are dormant, foreign banks in Japan are quite active. But not in filling the research gap left by the domestic players. No! They are packing their bags and leaving to more "lucrative" destinations in Asia. Incredible! The last time I've seen such foolish action by international banks was during the bottoming out of the long bear market in commodities in 1999/2000. They closed down their commodities division to move to more "lucrative" business spheres (MBS I reckon).

Goldman Leads Foreign Banks Accelerating Job Cuts in Japan   (Bloomberg)

Tokyo loses out as foreign banks refocus   (FT)

Garnish those aforementioned conditions with willing vodoo economists and embedded financial journalist hawking the myth of Japan's lost decades and its immediate demise (The land of the setting sun/ The land of the rising sum!) all over the global financial media; let the CEOs of japanese companies brief their shareholders year in and year out on how difficult and challenging business conditions are and that there is no prospect of any improvement in the future (while retained earnings and cash holdings keep on increasing to ever greater heights and hidden reserves are mounting). 

Volà! You have a major country with one of the most inefficient capital markets and compelling valuations in the world. This country is called Japan: A Value Investor's Dream!