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Date: 2020-09-04 07:03:45
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“Japan is a value play,” says John Vail, chief global strategist at Nikko Asset Management. “But that’s also coupled with long-term structural improvements in corporate governance, operational gearing to a global economic upswing, and extreme political stability.”
Japan’s benchmark index, the Topix, trades for under 15 times earnings in the Japanese fiscal year ending in March 2022, compared with a price/earnings ratio of about 21 times for the S&P 500. The Topix yields 2.4%, versus 1.7% for the S&P 500 and trades for 1.2 times book, versus 3.9 times for the S&P.
While the overall market is inexpensive, better Japanese companies trade for loftier valuations—reflecting in part Japan’s ultralow interest rates.
Investors can get exposure to Japan through exchange-traded funds, mutual funds, and individual stocks, many of which have U.S. listings.
Buffett took a somewhat unusual route into the Japanese market. His Berkshire Hathaway (ticker: BRK.A) bought stakes in a group of opaque Japanese companies that combine the trading of commodities and other goods with investments. Like much of the Japanese market, they were inexpensive, with four of the five companies trading below book value.
“Buffett has told Japanese investors, ‘Don’t ignore your own market,’’’ Vail says. “That could be very helpful.”
Japan, to be sure, has lots of negatives: an anemic economy, low corporate returns, and poor demographics. “A lot of investors get discouraged about deflation, an aging population, and a cultural gap in how managements think,” says Yoko Sakai, the director of research at international investing firm Harding Loevner based in Bridgewater, N.J.
But she says the situation has improved a lot since Abe made structural corporate reforms one of his three “arrows” to boost the economy after becoming prime minister for a second time in 2012, with easy monetary policies and fiscal stimulus.
The Topix is up just 12% in the past five years, against a 76% advance in the S&P 500, and it remains 43% below its 1989 peak. The Topix, like the S&P 500, is weighted by the market value of its components.
The other main Japanese index, the Nikkei 225, is price-weighted like the Dow Jones Industrial Average and is less representative of Japan’s major companies.
There is nothing like the Nasdaq in Japan. Like Europe, Japan lacks a large and innovative tech sector.
Its top five companies— Toyota Motor (TM), Sony (SNE), SoftBank Group (SFTBY), Keyence (KYCCF), and Nintendo (NTDOY)—have their attributes, but don’t compare to the U.S. giants. Only four companies in Japan have market values above $100 billion—against about 65 in the U.S.
What Japan possesses instead is a group of high-quality industrial businesses like Toyota; Keyence, the leader in factory automation; Daikin Industries (6367.Japan), a top global maker of air-conditioning equipment; and Nidec (NJDCY), an innovative, major producer of electric motors.
“Japan is more like Germany than the U.S.,” says Masakazu Takeda, a portfolio manager at Sparx Asset Management in Japan and co-manager of the Hennessy Japan fund (HJPNX). “There aren’t too many internet companies, but Japan has highly competitive manufacturing businesses. Manufacturing excellence is one of Japan’s advantages.”
So how do you play Japan?
The largest ETF is the $10 billion iShares MSCI Japan (EWJ). The $1.5 billion WisdomTree Japan Hedged Equity ETF (DXJ) neutralizes the yen-dollar currency risk. One benefit of the WisdomTree fund is that export-oriented Japanese companies tend to do well during periods of yen weakness, which would offset equity gains in an unhedged fund.
Active managers in Japan have been able to gain an edge over broad ETFs given a still-large number of low-return companies. The Hennessy fund, for instance, has excelled with a 13% annualized return in the five years through Thursday, against a 7% annual return for the Topix index.
Hennessy’s Takeda is partial to Daikin, the world’s No. 1 air-conditioning company and a rival to Carrier Global (CARR) and Trane Technologies (TT) in the U.S. “It’s not just air conditioning, but air-purification technology, which is important in a Covid-19 world,” he says.
Daikin, however, trades for about 29 times projected earnings in its fiscal year ending in March 2022. The U.S.-listed shares (DKILY) trade around $18.
Simon Fennell, co-portfolio manager of the William Blair International Leaders Fund, favors Keyence, which he calls the “world leader in factory automation” with an attractive growth outlook. Its Japanese shares (6861. Japan) are richly valued at 45 times fiscal 2022 earnings. Its U.S. shares fetch around $416.
Toyota Motors, long the world’s most valuable auto company, was eclipsed this year by Tesla (TSLA), which now has a market value of $385 billion, about double Toyota’s $185 billion. “Toyota is an extremely well managed company with strong returns and a fortress balance sheet,” says Eric Liu, a portfolio manager of the Oakmark Global Select fund. “It’s a very cheap stock.”
At around $130, Toyota trades for about 11 times projected earnings in its March 2022 fiscal year and yields 3%. It had net cash and equivalents of more than $80 billion at its core car operations at the end of March, or nearly 50% of its market value.
Toyota has been slower than some of its competitors developing all-electric vehicles, favoring gasoline/electric hybrids, where it leads the industry. It plans to introduce a group of EVs in coming years backed by strong battery technology.
Liu notes that Toyota generates the auto industry’s highest returns and is the only car maker profitable in all five major regions of the world. “As value investors, we think Toyota is much more attractive than Tesla,” Liu says. “The electric-vehicle space will get very competitive in the coming years.”
SoftBank, controlled by Masayoshi Son, amounts to a tech and e-commerce fund trading for just over half its estimated net asset value. Its influence as an investment company was underscored on Friday by reports that it had bought call options tied to billions of dollars worth of tech stocks.
Its most valuable asset is a roughly 25% stake in Alibaba Group Holding (BABA) worth some $200 billion. It also has a stake in SoftBank, a Japanese wireless carrier, and owns Arm Holding, a U.K. chip designer that SoftBank may sell or take part of it public. And it operates the SoftBank Vision Fund, which was stung by a high-profile loss in its investment in WeWork. The fund, however, accounts for a little more than 10% of SoftBank’s net asset value. Its U.S.-listed shares (SFTBY) trade at around $30.
Sakai of Harding Loevner likes Makita (1631.Japan), a maker of power tools that competes against Stanley Black & Decker (SWK). Makita’s strength in lithium ion battery technology has enabled it to produce cordless gardening tools like hedge trimmers and leaf blowers that are safer, quieter, and better for the environment than gasoline-powered models.
The stock isn’t a bargain at 26 times projected fiscal 2022 earnings. U.S.-listed shares (MKTAY) trade around $45.
Still, the overall Japanese stock market is inexpensive and features improving returns and some world-class companies.
Sources: Bloomberg; FactSet
Write to Andrew Bary at email@example.com