Sunday, November 2, 2008 0 comments ++[ CLICK TO COMMENT ]++

The Risk With Japanese Stocks

This is a point that I have brought up several times but it's worth repeating so that newbies don't fall for it. Japanese stocks are very cheap if you look at metrics like price-to-book-value or price-to-sales. But they have horrible return on equity and are not shareholder-friendly at all. James Surowiecki--didn't know he had a blog--talks about this point:

The lesson of Japan is that a country’s stock market is not going to rise over time if, over time, its companies fail to create economic value for their shareholders. Felix says that “Japanese companies are well-run.” But, in fact, they’re not well run, at least by the standards that are relevant to shareholders—return on equity, profitability, growth, and managing cash flow in a shareholder-friendly way. By these standards, Japanese companies have historically been run badly, and while they’ve improved some in recent years, they’re still far behind American firms on all of these metrics.

In the 1990s, the average return on equity for the Nikkei was around four per cent, and in the second half of that decade and into the early years of this one it fell below two per cent. (In the U.S., the average R.O.E. is closer to eleven to twelve per cent.) According to this report, between 1998 and 2003, of all large-cap Japanese companies, only eight had an R.O.E. above ten per cent, which is a completely ordinary performance by U.S. standards. And even now, Japan’s average R.O.E. is by far the lowest of any major economy.

Anyone thinking of investing in Japan or is curious about the situation over there should read the full entry.

Warren Buffett has also alluded to this feature of Japan in the past. He has pointed out that cost of capital is very cheap in Japan (good companies were literally able to borrow at close to 1% through most of the last decade) but practically no one is able to generate returns on equity much above 1%. Buffett said that this was the case even in the 80's when Japanese companies were growing and becoming dominant.

A lot of value investors, ranging from Jean-Marie Eveillard, Martin Whitman, Charles Brandes, and James Grant, have bought Japanese stocks at various points in time over the last decade. Yet I wonder how many of their investments have gone nowhere. Every time I look up a Japanese company, I always find low ROEs. There are exceptions, like Toyota, but most are terrible investments.


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