10 Years Blogging: Japan Still Undervalued

 

Ten years ago I started my little Journey into the Bloggosphere. To be honest, the experience of running the blog in the current form has been rather sobering. The main reason? Limited interest in general and little engagement of the audience in form of comments, links on social media, etc. Actually, the blog vindicated my deep- rooted antipathy towards social media!

Be it as it may! I still enjoy writing about my ideas and findings for myself. And for inexplicable reasons I still publish some every now and then on this blog.

In this post I will make the case that Japan was, and still is, a wet dream for any contrarian value investor, a truly endangered species. I would even argue that the Japanese market has never been more attractive at the time of writing.

Back in 2012 the entire Japanese stock market was on sale. Long established quality companies with big moats offering highly appreciated products could have been picked up at extremely favorable terms. Decent companies were trading at 1-2 times Net Current Asset Value (NCAV). Japanese net- nets were dividend paying surplus companies, often generating decent free cash flow. The whole spectrum and flavor of value could have been found for those investors venturing off the beaten track. The only problem? Nobody dared!

Almost everyone succumbed to buzzwords like: Japan the buck searching for a windshield; Japan the widow maker trade, Land of the rising sum, etc. Those labels would generate significant click rates and instant approval in the Fintwit community. Mainstream economists did not perform any better. They forecasted that Japan’s decline would mirror that of Argentina over the 20th century. And established financial media outlets like FT, Bloomberg, WSJ chanted the chorus of Japan’s imminent gloom and doom wholeheartedly, without even bothering (double) checking micro and macro factors.

Banks in Japan had been reducing staff for almost 20 years. International banks started to close its Japan branches in 2012 and relocate to Hong Kong or Singapore. Equity analysts within Japan more than halved from peak (1990) to trough (2012). Further draining the expertise that could uncover the value to be found on the Japanese Stock Exchange.

Basically, the whole situation in 2012 was a superficial diagnosis and knee jerk reaction by a bunch of ignorant morons that a developed country, the world’s third largest economy and stock market, had caught a terminal illness. It was a social proof loop, forming irrespectively of facts on micro/ macro level suggesting otherwise and/ or being well compensated, because it killed the very expertise that could do so.

It was even worse. The value investing community also succumbed to the doom narrative. I am only aware of a handful of prominent investors. like Jean- Marie Eveillard, pointing to the incredible opportunity in Japan. That was the background I picked the majority of investments in Japan.

In hindsight we all know what happened. Along came Shinzo Abe with his bold plan of Abenomics. The stock market literally exploded, annihilating those East Asian PM’s that were actively shorting Japan or neglecting it. Institutional investors got interested in Japan around 2015 after the stock market roughly doubled. The interest only lasted for little more than a year. From 2016, foreigners started selling once again and never reversed course. Prime example is ADIA, the Abu Dhabi Investment Authority, closing down its Japanese investment team. Reason? Looking for higher growth countries! Neglecting the fact that no positive correlation between GDP growth and stock market returns exist.

It is even more depressing. From the onset of foreigners selling Japan inc., profits, pay- outs, share buy backs, M&A and shareholder activism has kept its upward momentum. It appears that international investors got bored about something. I have not figured what it might be. Are profits and pay- outs worth less in Japan than in the rest of the world (ROW)?

Ten years ago, Japan and the United States started at similar valuation levels. Since valuations in Japan have gone down, while those in the ROW, especially U.S., expanded. And Japan had the best corporate efficiency improvement in G7 countries during that time span. Granted, a bunch of stocks within Japan had a stellar performance, like in the ROW. But stated price/earnings ratios in aggregate are lower than ten years ago, and over half of the companies still trade below tangible book. Those hard numbers even understate the true undervaluation in Japan, given high cash balances, cross shareholdings and the conservative nature of Japanese accounting.

For sure, also in Japan companies trading below book for a simple reason. The operating business does not cover the cost of capital. Many Japanese department stores fall in this bucket. Only surviving by selling real estate assets purchased decades ago. Although cheap I am not interested in such stocks. Personally, I am more interested in good companies trading around 2 times NCAV (Fukuda Denshi) and decent companies trading around NCAV or below (Nitto Kohki).

Even better, in Japan many of those companies are trading at negative enterprise value. A situation where the net cash holding is worth more than the market capitalization. Basically, it is like buying a used car where one figured out the asking price is covered by cash stashed in the glove box. A truly staggering situation and, like ten years ago, only available in Japan in a meaningful number.

Since starting the blog corporate Japan has seen dramatic improvements at various levels. Think: Management, efficiency, pay- outs and corporate governance, to name just a few. Profitability of Japanese companies need not fear comparison with the ROW and has been on par with the U.S. Even better, the increased profitability and efficiency was achieved while simultaneously reducing the corporate debt level. In stark contrast to the U.S. there was and is no financial engineering in Japan!

In my opinion it is the strength of corporate Japan’s balance sheets in combination with incremental improvement in efficiency that will be a decisive factor for national and international investors to revaluate Japanese equities in the coming ten years. 

If this blog will be around another decade in the current form has to be seen, and not only depends on the author, but also its audience!