Japan, the world’s third-largest economy, presents compelling — but perhaps overlooked — equity investment opportunities.
There are three key reasons why we believe that prudent investors may do well to consider Japanese equities:
1. Rich opportunities - deep market, poorly understood
Japan is home to one of the world’s largest stock markets, yet analysts don’t cover 45% of the Tokyo Stock Price Exchange, or Topix,1 stocks. By comparison, only 3% of the stocks on the Russell 3000 Index,2 a proxy for the US equity market, lack analyst coverage. So, we see fertile ground for investors with strong research capabilities to unlock hidden value in Japanese equities.
Plus, several Japanese stocks have multiplied their share prices as much as five or 10 times over the past decade.
Chart 1: 10-year returns of Japanese stocks
Source: Bloomberg, (calculation period: September 2012 and September 2022). For illustrative purposes only. No assumptions regarding future performance should be made.
While the opportunity is huge, investing in Japan also has its own challenges. Weak coverage and governance risks require effective due diligence and an active approach to contain risks and realize value.
2. Good companies with strong fundamentals
Japan is home to many high-quality firms with strong balance sheets — two characteristics of companies with strong fundamentals. What’s more, many of these companies have sustainable cash flows and defendable competitive advantages, which are also attractive qualities.
The fact that Japan is home to such companies creates an opportunity for higher-than-average returns on equity and dividend payout ratios than the market. This also speaks to materially lower debt-to-equity ratios.
Almost half of non-financial companies listed on the MSCI Japan Index have net cash more than 20% of equity.3 Of these, the best-run firms are well placed to sustain profitability regardless of the macroeconomic environment. Despite concerns of a weaker outlook, companies are still generating strong cash flows and maintain solid balance sheets, allowing them to buy back shares at a record pace and invest in their future growth.
Not only do these companies exist in Japan, but they may be available at attractive valuations. Price discrepancies among high-quality companies may enable investors to extract long-term value.
3. Long-term structural themes remain unchanged
While the impact of the economic slowdown has been increasingly visible, there are medium- to long-term trends that we expect to continue to support innovation and opportunity. These include:
- The rise of machines – We expect robotics and the Internet of Things to expand in Japan, generating opportunities in software applications and industrial uses
- The energy transition – As nations around the world commit to less fossil-fuel-dependent energy, there could be opportunities for automotive electrification, energy-efficient components and in recycling
- Digitization – Software is an increasingly important part of the services sector and we see long-term opportunities in IT infrastructure
- Healthcare and technology – Japan is situated at the cutting edge of medical innovation, which could create long-term opportunities
- The rise of Asia’s middle class – as the middle class expands throughout Asia, demand for premium products and name brands is likely to rise
Why now?
During the second quarter of 2022, the Japanese economy recovered to its pre-pandemic size thanks to increased consumer spending and the end of certain Covid-containment measures.
While it’s possible, of course, that Covid spikes could strike again, as they did in the summer of 2021, Japan has seen a more conscientious adherence to Covid-containment guidance, such as social distancing, than some other countries, which bodes well for continued economic recovery.
At the time of writing, inflation remains relatively moderate in Japan compared to many other parts of the world. Consensus expectations are for moderate growth to continue in Japan in the short term.
The bottom line is that Japanese business are well placed for economic recovery versus many other major economies worldwide.
1 The Tokyo Stock Price Exchange, or Topix, is a capitalization–weighted index of large and mid‐sized companies listed on the Tokyo Stock Exchange.
2 The Russell 3000 Index is an unmanaged index considered representative of the US stock market. The Russell 3000 Index is a trademark/service mark of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co.
3 CSLA, Bloomberg, March 2022.
IMPORTANT INFORMATION
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
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