Japanese Equities – a cheap equity market or a value trap
Given the traumatic events of the past few weeks, it is hard to imagine Japanese equities as being a particularly attractive investment. The fact that there are approximately 50 nuclear power stations located in Japan which, as we have seen to devastating effect, is a very seismologically active part of the world only adds to the risk of investing in Japan. However, based on current valuations, the market does look attractively valued.
A number of interesting articles in the financial press highlight Japanese equities
There were a number of interesting articles in the Financial Times over the weekend focusing on Japan. Two are particularly noteworthy in their assessment of the Japanese equity markets.
“Japanese companies are half as expensive as US companies”
The first one by John Authers in his weekend column highlights the risks but also the opportunity of investing in Japanese stocks today.
http://www.ft.com/cms/s/0/0722d6f2-51b1-11e0-888e-00144feab49a.html#ixzz1HEmv9Goo
Quoting directly from the article:
“Japan’s litany of problems is well known. Its economy has stagnated for two decades, there is no room for stimulation from easier money, the government has the developed world’s most serious deficit and its population is ageing, suggesting that things are destined to get worse. If you want to live in a country enjoying fast economic growth, you might do better than move to Japan. But none of this precludes the chance that the market is pricing Japan’s stocks too cheaply.
If we assess value relative to other countries, Japan has been cheap for ages and looks infeasibly so. Judged as a multiple of book value (assets minus liabilities on their balance sheets) Japanese companies are half as expensive as US companies.
Judged by cyclical price/earnings multiples (comparing share prices to the average earnings over the past 10 years), Dylan Grice of Société Générale shows Japanese stocks, at a multiple of 16 for the Topix index, are as cheap as they have been since the late 1960s. (Adjusting for inflation, they were slightly cheaper in 1978.)”
“Are Japanese companies really worth that much less than everyone else’s companies?”
The other article was written by Merryn Somerset Webb in the Money section of the FT:
The article again highlights some of the reasons why the Japanese market is attractively valued. A number of quotes stand out in particular.
“The market is fundamentally cheap in a way that hasn’t been the case since 1989. The price to 10-year reported price/earnings ratio (just a longer term version of the p/e ratio) is at “levels unseen since the early 1970s”.
At the same time, Wood points to the fact that the price-to-book ratio on Tokyo’s Topix index is now just below one – “you could buy the lot for less than you’d get flogging their assets in a fire sale.”
“A price-to-book ratio at this level is 40 per cent below the global average. Are Japanese companies really worth that much less than everyone else’s companies? I can’t think that they are.”
Nor can Mizuho Bank’s Tomochika Kitaoka. This would only be a correct level, he says, if “the very existence of Japan was at risk”. It is not.
Over the last 20 years many a good analyst has stated that now is good time to buy Japanese equities only to see prices fall further. The following chart illustrates the highs and lows of Japanese equities over the last 40 years, with the last 20 being a near continuous grind lower.
Japanese equities – 20 years of disappointment
Nikkei 225 in local currency
Source: Bloomberg
But also 20 years of improving valuations
MSCI Japan P/E ratio
Source: Bloomberg
Valuation looks compelling but…
Despite the devastating impact of the earthquake and tsunami on Japan and the significant economic and structural problems facing the economy, the current valuation of the local equity market does look compelling. However, it still remains a market with high level of attendant risks, not least of which is the battle to contain the fallout from Fukushima Daiichi nuclear plant. The fact that Japanese official rates are at rock bottom and with the debt to GDP ratio in and around 200% means that the authorities have little conventional room for manoeuvre in terms of economic stimulus. Having said all that, for equity markets to be cheap, there has to be a reason and Japan has many.
A simple way of investing in Japanese equities is via the Irish Life Indexed Japan Equity fund which tracks the FTSE Japan Index, which is a high risk fund on our risk scale. Like all higher risk investments, such as country and sector equity funds for example, they should only form a small part of a well diversified portfolio as many things can go wrong and volatility can be very high.
Nevertheless, I will leave the last word to Warren Buffett when he stated in a recent interview: “If I owned Japanese stocks, I would certainly not be selling them because of the events of the past 10 days or so. Something out of the blue like this, an extraordinary event, really creates a buying opportunity.”
