WHY INVESTORS SHOULD NOT IGNORE JAPAN - SUMMARY OF LINCHPIN WEBINAR ON 26TH AUGUST
Our latest Linchpin webinar focused on why investors should pay some attention to Japan. It was held for Finnish investors – we have an active clientele there - but the arguments of course apply to all, so we are happy to share them. We held it in combination with Arcus Investment, the Japanese value equity purist, and the main speakers were Peter Tasker, one of their founding partners, and Ben Williams from the investment team.
Japan remains the third largest economy in the world with significant expertise in many high tech and precision industries, and substantial trade links with both the US and China. Over the past thirty years, the corporate sector has changed significantly. We’d note the huge improvement in corporate governance and much greater focus on shareholders’ interests.
As Peter pointed out, the results of this can be seen in the rise in corporate asset margins since 2000 and profit margins in the last ten years. Free cashflow generation and pay-out ratios as a consequence have both risen massively. As a result there has been a substantial fall in leverage in significant contrast to the US. This means both that Japanese companies are less vulnerable to a liquidity crisis, because they won’t have debt to refinance, and also have more scope to take advantage of opportunities. The opposite is true in the US.
Peter also looked at the ratio of price to tangible assets, where (Bloomberg data) Japan (TOPIX) stands at 1.44x against the US (S&P 500) at 12.8x. That is partly down to the largely intangible nature of the large US tech stocks, but asset backing does indubitably provide a margin of safety in worst case scenarios. As Peter argued, even if in the future we do move into a more digital world or one where intangibles such as goodwill form a large part of company’s balance sheets, Japanese companies will still be able to sell much of their physical asset base (e.g. real estate) and return the value to shareholders.
It’s also partly down to price action: after ten lean years for value investors, it looks like value stocks in 2020 are close to capitulation. Peter pointed out that it is not the first time that value has faltered when a class of stocks has reached an extreme valuation, most notably in the 2000 dot-com boom. It is important to remind oneself that value remains the long-term winner by a long stretch, and periods of capitulation such as this provide an attractive entry point.
From a bottom-up perspective Ben looked at Keyence, a stock beloved of foreigners but which is the antithesis of what Arcus like to hold. It has delivered eps growth of around 10% consistently, but even if it continues, is an all-time high PER of 50X worth paying for this and a meagre dividend of 0.5%? By contrast a portfolio of value stocks as held by the Arcus Japan Fund yields 4% (historic pay-out) on a PER of 13x prospective. Keyence has little upside potential unless it exceeds analysts’ demanding forecasts, whereas even if ‘value’ remains unloved, investors are still being paid a marginal 3.5% per annum to hold it. Over time, and in a 0% interest rate environment, that is substantial.
Japan is clearly under-appreciated and, at least in bits, very cheap indeed in both absolute and relative terms. Nobody can say when the market trend will swing away from growth but investing early has historically been the winning approach in Japan. We would argue that there are even better arguments than usual for taking that route in 2020, but even if we are wrong valuation and income levels mean that the downside and the opportunity cost of doing so is limited.
The Arcus team has stayed true to its style over 22 years of good and less good times. It is one of the few teams with a substantial bi-cultural research team based in Tokyo, not unimportant in a post MIFID-2 world where good quality research is becoming scarcer.
If you would like to see the slides or to discuss this further, please contact us at email@example.com.