February 21, 2011
By HIROKO TABUCHI
TOKYO — Japan’s government finances are on the verge of collapse, and its economy has floundered for two decades. So why do many global investors consider the Japanese stock market a buy?
“Japan is by far one of the cheapest markets in the world,“ said Charles de Vaulx of International Value Advisers, a New York-based investment firm. “It’s so universally hated, yet it might be one of the world’s best-performing markets over the next five years.”
Of the $12.7 billion in assets Mr. de Vaulx manages, 15 percent is already invested in Japan, and he is considering loading on even more. “So many Japanese companies are well managed from an industrial standpoint,“ he said.
In the week ending Feb. 11, investors based outside of Japan were net buyers of Japanese stocks for the 15th consecutive week, according to data released by the Tokyo Stock Exchange. That was the longest such run since 2005.
An attraction for the bulls is the fire-sale prices. Although the benchmark Nikkei recently hit a nearly 10-month high, it is still more than two-thirds off its peak before Japan’s real estate and stock market bubble burst in 1990.
Shares in Tokyo are also about 20 percent off their levels before the financial crisis hit in 2008 — one of the few major markets that have yet to rebound.
Prices are so depressed that, at the end of December, nearly two-thirds of the 1,700 companies listed on the Tokyo exchange’s main section had price-to-book ratios below 1. That means, in effect, if one of those companies was dismantled and sold off for its parts, it would fetch more than its market value.
“These stock prices are saying there’s no hope whatsoever for Japanese companies, and that’s simply not true,“ said Tony Roberts, who manages a $2 billion-dollar Japan fund for London-based Invesco Perpetual. “There are lots of great companies in Japan that add a lot of value,“ he said.
Certainly Japan can still give investors reasons for doubt — like the long-term effects of the government’s high debt and aging population. There is also the paltry profitability of companies like Sony, which has averaged a 3 percent return on equity over the last five years while its Korean rival, Samsung Electronics, has surpassed 13 percent by the same measure.
Yet “foreign investors who were once automatically giving Japanese stocks a pass are now taking a second look,“ said Junya Naruse, chief strategist at the Daiwa Institute of Research.
For one thing, the economic recovery gaining strength in the United States is emboldening investors, while helping brighten the outlook for Japan’s export-led economy. At the same time, turmoil in the Middle East, rising food inflation and tighter money policies in fast-growing economies like China are prompting some global investors to think twice about emerging markets.
In fact, now that China is Japan’s top trading partner, Japanese export stocks seem a less risky way to invest indirectly in Chinese growth.
And while corporate earnings are far from booming, total net profit at Japan’s publicly listed companies has more than doubled this fiscal year, according to a Nikkei tally.
More Japanese companies have also tried to counter investors’ longstanding complaints that companies here hoard too much cash, instead of investing it or returning it to shareholders. Some companies have raised dividends. Others, including Japan Tobacco and the semiconductor maker Rohm, have announced share buybacks in recent months — moves that help elevate the value of the companies’ remaining shares in the market.
Meanwhile, if the inflation threatening other countries spills over into Japan, it could finally help the country reverse depressed prices, with positive spillovers for the stock market.
Still, investors caution that making money on Japanese stocks requires an intimate knowledge of Japan’s corporate landscape. Instead of sticking to well-known global companies like Toyota or Sony, investment managers aim to ferret out small- and medium-size companies trading below their potential.
International Value Advisors, for example, has invested in relatively obscure companies like Kanamoto, which leases construction material, and Milbon, which makes hair care products.
“With proper stock-picking, the Japanese stock market is a place where one can make money,“ said Mr. de Vaulx of International Value Advisors.
Some activist investors, meanwhile, are trying to coax Japanese companies into creating more value for shareholders, rekindling an issue that ignited contentious battles between foreign investors and Japanese management in the mid-2000s.
Earlier this month, Governance for Owners, an investment firm and shareholder advocate based in London, and Tokio Marine Asset Management of Japan said they would jointly start a fund that would invest 100 billion yen ($1.2 billion) in underperforming small- to mid-cap Japanese companies and take an activist role.
“We feel that there are opportunities in Japan, but there are issues that need addressing,“ said Simon Wong, a partner at Governance for Owners, pointing especially to the cash hoarding that he said still characterized many Japanese companies.
Domestic investors have started to mirror these moves to home in on underperforming Japanese shares. In late January, Nomura Asset Management set up the Undervalued Japan Stocks Investment Trust, attracting 73 billion yen ($878 million) in retail money, more than double the size of the largest new Japan stock fund last year, according to the research company Lipper.
Renewed investor interest is welcome in a market that has lost its thunder to faster-growing regional rivals. By share turnover, the Tokyo Stock Exchange lost its standing as Asia’s top bourse to Shanghai in 2009, although Tokyo still has the continent’s biggest exchange by market value.
“Japan offers a very attractive environment: our banks are stable, we are a democracy, and our markets are open and transparent,” said Atsushi Saito, chief executive of the stock exchange. “Investment hot spots might be fun for short-term money play. But for the stable management of funds, Japanese equities are much better,” he said.
At least until they aren’t.
Currently, global markets are volatile over the Middle East turmoil. And some political events could sway Japanese stocks. The Japanese government has promised to decide by June whether it will participate in negotiations for a pan-Pacific free trade zone — a potential boon for industry, but opposed by farmers.
The same month, the government plans to outline steps to raise its consumption tax, which, if executed poorly, could hurt Japan’s economic recovery.
“The rally should continue until June — after that, it all depends,“ said Mr. Naruse, of Daiwa. “It’s a fragile recovery, and investors could lose faith in Japan again, all at once.”
Moody’s Downgrades Outlook
TOKYO (AP) — Moody’s Investors Service on Tuesday downgraded its outlook for Japan’s credit rating because of concerns over its national debt. The rating agency changed its outlook for Japan’s Aa2 rating from stable to negative. The move was not unexpected. Last month, Standard & Poor’s cut Japan’s credit rating from AA to AA-.
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