Savor the low-hanging fruit
Imagine you are standing at the gate of a vast orchard. You see beautifully ripening fruit everywhere, extending to a never-ending horizon. How could there be so much produce, low-hanging and visible to the naked eye, yet so few people around? Even hired help is hardly noticeable. In this world of instantaneous communication and social media there seems to be a major disconnect. Perhaps people who have enjoyed the fruit have shared the message, but it was drowned out by other messages, news, and conventional wisdom. Or maybe some pickers arrived too early and became dismayed at being denied instant gratification. Others might feel smarter than the orchard and will go elsewhere; they will teach the orchard a lesson.
The scarcely-visited orchard metaphor represents the Japanese stock market. The abundance of ripe fruit reflects the thousands of companies (the majority of the market) that have highly appealing investment valuations. Some are so cheap and neglected, it’s said they are “better off dead than alive,” meaning the company ought to be liquidated and the assets returned to shareholders. Indeed, companies and the market at large remain cheap, since so few bother to do any looking around, picking up and examining. Even the domestic institutions that should be providing trading liquidity (and making longer-term investments) to the market lack a strong presence.
A very select few have shown real interest in Japanese stocks, and fewer yet have stayed the course.
Overall, there’s no “equity culture” in Japan. 401(k)-type retirement plans haven’t caught on, and Japanese mutual funds tend to have high fees and be overly faddish. In a mostly reactive and conforming securities industry (in Japan and elsewhere), one will achieve job security and otherwise not subject oneself to undue risk, sticking with conventional wisdom and the so-called herd. Someone might have seen the orchard – it would be hard not to – and maybe even breathed in some of the sweet scents. But it can be too much of a leap to do any picking if nobody else is; for some maybe there is fruit that they have never seen before. (How does one judge it. Is it ripe enough to eat?)
In terms of investments, buying the “hot” stock means being in line with everyone else and paying a premium. When hot turns cold it can be rough going, as gains evaporate or losses widen and the voice inside won’t stop questioning every thought (as opposed to previously calling you a genius). For industry professionals it is certainly easier and safer to dismiss Japan given its ostensible plethora of problems.
Ignoring the Naysayers
The official data and many pundits say Japan is doomed. The tragic triple-disaster in Tohoku only worsened Japan’s economic plight, it is believed. The print media, when it covers Japan in the US for instance, would have you believe that human sightings are becoming rare. Successful Japanese products are a thing of the past, it’s claimed. Estimates abound of Japan’s population halving or even disappearing someday.
No wonder nobody wants to invest in Japan.
But residents and even short-term visitors to Japan recognize the folly of such doom-saying and narrow trend-spotting. No, Japan is not a “bug searching for a windshield” as one pundit declared in 2010, pinpointing the nation’s implosion in the next two or three years.
It’s actually not too difficult to find data showing some bright spots for Japan. Nor is it hard to find empirical reasons to be optimistic.
Conversely, it’s all too easy to rhetorically regurgitate headline statistics, such as Japan being the most heavily indebted nation in the world. In fact, Japan happens to be the world’s largest creditor nation, with substantial foreign reserves (second largest in the world). Barring once-in-a-lifetime disasters and global depressions it has solid trade surpluses, and it prints its own currency (which added to the fact that foreigners own an insignificant amount of Japanese government debt is a great convenience to provide stimulus).
Rather than face imminent default, Japanese government bonds are being rolled-over at lower and lower rates. Regarding Japan’s protracted economic malaise, it turns out that the shrinking labor force, combined with productivity gains, have allowed the Japanese economy to achieve similar, if not at times higher, growth rates than the US and EU.
Japan’s economy and booming stock market – once the marvel of the world in the 1980’s – underwent a serious correction during a period that is now known collectively as the “lost decades”. Over-leveraged financial institutions, companies, and individuals would go on to shore up their respective balance sheets. Meanwhile, the government would end up being the spender of last resort – and continues trying to stimulate the economy – while everyone else was acting belatedly prudent. Today there is hardly any need for so much fiscal prudence. Publicly-traded Japanese companies have shown great resilience against unpredictable and unfathomable hardship from natural disasters and a stubbornly strong yen juxtaposed with a highly unfavorable global economy. Corporate balance sheets are flush with cash and quality assets while companies continue to generate positive cash flows and pay higher dividends. The strong yen hurts competitiveness but does offset import costs and it makes overseas acquisitions more affordable. Discipline is needed not to overpay, however.
Now more than ever, Japanese companies can and should be boosting wages broadly and more generously compensating their most talented employees. Anachronistic systems of lifetime employment and strict seniority-based hierarchy need to be broken down further. The economy stands to benefit immensely from both younger workers spending more readily on all things surrounding family formation and expansion, while the elderly ought to be putting more and more of their savings into the economy to get the most out of their golden years.
Companies in fact will find the means to pay younger and talented workers more from the cost savings of their elder-most employees retiring. As for corporate equity, ever-higher dividends should at some point soon trigger a mass enlightenment that stocks can represent reliable and significant sources of income as well as offer viable opportunities for capital gains as more people are actively participating in the economy. If only Japanese companies would pay dividends quarterly as companies do in the US; I believe more Japanese (and non-Japanese) investors would be more inclined to invest in Japanese stocks.
A company that helps summarize where Japan stands is Unicharm, a leading personal care products manufacturer that is best known for its diapers. The joke is that more diapers were sold to the elderly last year than consumed by infants. Therefore, naturally, the argument goes that Japan is on its way to disappearing. Unicharm shareholders are getting the last laugh as the company has done very well indeed selling diapers domestically and to faster-growing Asian economies. Over the past decade its shares have increased threefold in value and trade at a deserved premium to assets and earnings. Similarly, one would think an apparel company could hardly flourish in Japan, yet Fast Retailing (known for its Uniqlo shops), has seen its shares grow by about four times during the same period. These are examples of companies where the market has rewarded growth. And there are others. But there are also companies that, though they may lack robust growth prospects, have mouth-watering valuations that imply depression-like circumstances. (Remember the “worth more dead than alive” reference earlier.)
The memories of debt-laden companies, zombie-banks, and free-falling land prices of yesteryear are apparently hard to erase. This is indeed a blessing for value investors looking to buy discounted stocks. Less popularity means better, even excellent, prices. Known as the ultimate “value trap,” the Japanese market will one day be priced at least at a modest premium given the very circumstances that investors are overlooking today. Balance sheets and cash flows are likely to remain solid. In the meantime, the occasional territorial dispute and threat from North Korea notwithstanding, the Asia region offers the world’s highest growth rates at a scale large enough to move the needle meaningfully for Japanese companies. Investors have already missed some great opportunities, having written off Japan, but there remain plenty of high-quality, under-valued companies sitting in plain view like the fruit in our abandoned orchard metaphor. For the more sophisticated investor, it is probably a surprise that Japanese shareholder rights rank amongst the most generous in the world, and excessive executive pay is rarely an issue.
I conclude with the example of Nintendo, a familiar company that has a long history of success and tremendous brand value. After a 20 percent rally from the end of July, when it fell to a decade-low level, its shares (in late September at the time of writing) are still trading at merely the value of net tangible assets (the company has very negligible liabilities) with essentially no value being ascribed to either its earnings power or intellectual property.
With no shortage of negative takes on and investor disinterest in Nintendo through the summer, ironically the higher its shares climb before its next-generation gaming system launch in November (and presuming a successful launch) the more investors will pile in. In the meantime, Nintendo continues to remain a low-hanging and increasingly ripe fruit.