Thursday, January 10, 2008 2 comments ++[ CLICK TO COMMENT ]++

How Cheap is Japan?

You often hear stories mentioning that Japanese stocks are cheap. How cheap is it exactly?

Thanks to John Christy of Borderless Investor for the reference to the world S&P indices. I have been using the S&P site to pull data for a while but never noticed the section of the website containing all global index data in one table. Here are some sorted summarized tables by some key valuation metrics for developed countries. I have highlighted Japan in blue.


Dividend Yield



Price to Sales



Price to Cash Flow



Trailing P/E



IBES Forward P/E




ROE





Price to Book Value



Conclusion

Well, first of all, a lot of this analysis depends on the index methodology and constituents. Cap-weighted indices tend to emphasize the effects of the larger companies so if someone were a stock picker, as most value investors are, and picks small caps, none of these numbers may mean anything.

In any case, Japan ranks near the bottom in terms of dividend yield, trailing P/E, and ROE.

It's near the middle in terms of price to cash flow, forward P/E, and price to cash flow.

It's near the top when the following measures are used: price to book value, and price to sales.


I think these results confirm what I, and others, have observed for quite a while. Basically, the Japanese companies are not shareholder friendly. If you look at stocks from an earnings point of view, Japanese companies are terrible! Japanese companies have an ROE of 9% versus a typical US company's 17%. Japanese companies don't use enough debt (they are scared of debt due to their past problems), don't return enough money to shareholders (sitting on a lot of cash or underperforming assets is normal in Japan), and are generally not receptive to shareholder activism or financial engineering.

Because of the poor earnings management, P/E value looks high for Japanese companies.

What makes Japan look cheap is book value and sales. If you look at price to book or price to sales, two key value investing ratios, Japanese companies are quite cheap. Japanese companies have a price-to-sales of 0.8 versus USA's 1.5. Japanese company price-to-book value is around 1.6 versus a typical US company's 2.9.


Some articles I have read say that 40% of Japanese stocks are trading below book value. The listed numbers above don't show it so I suspect most of the companies trading below book value are small. Jim Grant of Grant's Interest Rate Observer recently remarked that Japanese small caps are trading at something like a 30 year low (based on valuation). This is a very powerful comment. How many times will you--in your life!--see a developed market with some sectors trading at a 30 year low?

The problem with small caps is that it's not easy to get English information, not to mention trying to grasp the business climate in Japan for those companies. Nevertheless, my goal is to try to find something worth investing in.

In addition to the valuation argument, another reason I would like to invest in Japan is because of the potential for the unwinding of the Yen carry trade.

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2 Response to How Cheap is Japan?

Anonymous
January 10, 2008 at 4:24 PM

Many Japanese compaines are overcapitalized -- they have too much cash and investments on their balance sheets. If you remove the low yielding cash and investments their "business" ROE and PE look much better. Unfortunately it's hard, (impossible?), to get managements to return the excess liquidity to shareholders....

January 10, 2008 at 4:35 PM

Totally agree with your post anonymous. I'm just hoping that they start treating shareholders better. Some articles seem to imply that the newer generation of executives aren't so "customs-oriented". Some positive trends (minor so far though): companies holdings annual meetings to suit shareholders; companies buying back stock (rare over there); increased foreign ownership by activists (still hard).

I'm just not sure how long it will take.

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