Johan Du Preez, Head of Japanese Equities at M&G Investments, examines whether it could be a new era for Japanese stocks
Loosely translated, the name given to Japan’s new Imperial dynasty, ‘Reiwa,’ means ‘beautiful harmony.’ Yet the dispersion between growth and value stocks – the widest since the tech bubble – suggests investors have been single minded in their investment choices. Historically, from 1995 to the onset of the global financial crisis, making money in Japanese value stocks proved a profitable strategy. But that all changed post-2016.
With growth at a distinct premium, investors preferred to focus on the structural themes of Japanese robotics, semiconductors and growing Asian consumer demand, stubbornly refusing to believe that Japan Inc. overall could grow its profitability following decades of corporate inefficiency. And yet a look at the underlying margins of these value-orientated large cap companies reveal that this method of thinking could be outdated. From their recent lows of 2008, operating margins of larger companies (ex-financials) have registered steady progress for almost 10 years. In many instances, median earnings growth for value stocks has proved superior to that of growth stocks. Looking at the data, the top quintile stock performers over the last three years (growth stocks) produced median earnings per share growth of 5.2%. This compared with the bottom quintile stock price performers (typically value stocks) which produced higher growth of 7.5% over the same time period. It would appear that the link between earnings growth and stock prices looks to have broken down as far as value stocks are concerned.
Nevertheless, for those investors who believe that Japan can make real progress on the corporate profitability front, there are bargains to be had.
Better corporate governance is contributing towards an improved bottom line. On the whole, return on equity has increased significantly. Both dividend pay-outs and share buybacks are nearing all-time highs. We are starting to see a greater willingness by company management to engage with investors. But many investors still remain unconvinced, pointing to the inefficiencies of the previous decades, where the preferred way of running a company was to accumulate as much cash on the balance sheet as possible. The result is that while corporate Japan has mostly caught up with other developed markets in terms of shareholder return and operating margins, half of Japanese companies are still trading below tangible book value, compared to 20% of European companies and less than 10% of US companies. As long-term investors, we believe this presents significant opportunities for global investors.