Postcard From The New Japan

The argument “You don't need to hold Japanese companies in your portfolio, they never change anyway” has been true for decades. 

But Japanese shares have been rising since the beginning of 2023. Just a temporary surge or is there more to it? I wanted to see for myself and traveled to Japan last week. With our partner for Japanese equities - the fund company Aspoma - I visited 22 companies of various sizes and sectors.

Let me preface my detailed report with three key takeaways:
1.    Japan is transforming.
2.    A closer look is crucial.
3.    The weak yen makes Japan a great and, above all, affordable vacation destination.

What was Japan’s problem for decades? 

After the bursting of the big 1980s stock market bubble, companies began to hoard liquidity. Beyond any reasonable level. It got to the point where some business models were traded on the stock exchange below their net cash holdings. In other words, you got the business model for free on top. Surprisingly, isolated cases of this still exist today. 

But what are two birds in the bush worth if I never catch them? These cash holdings were a treasure trove that minority shareholders couldn’t get their hands on. Which is why the market ascribed no value to this interest-free mountain of money. 

Abenomics and today's measures

A decade ago, then-Prime Minister Shinzo Abe launched a reform initiative that we now know as Abenomics. However, the Japanese system proved resistant to change. Until early 2023, when the Tokyo Stock Exchange (TSE) demanded that all listed companies take action.

This is remarkable because, after all, the TSE is funded by these companies through listing fees. Naturally, there are government initiatives behind this. But the government was smart enough to tackle the problem via the TSE rather than the complicated legislative process. Companies were asked “to implement management that is conscious of cost of capital and stock price.”

Suddenly, management had to deal with entirely new concepts, such as cost of capital or the return on capital employed. 

At the beginning of 2024, a year post-publication of the requirements, half of all Prime Segment companies had already published information on the changes. The TSE followed up in February, further specifying expectations. 

No one can avoid it

Not a single of the 22 companies I visited simply shrugged this initiative off. On the contrary, every presentation dedicated at least one slide to the topic. 

Two key metrics have emerged: the return on equity (ROE) and the price in relation to the book value (P/B). Many companies deliver far to low ROE to us owners and consequently often trade well below book value. They are now addressing how they intend to improve the situation. 

Nevertheless, we always had to follow up the discussion to find out whether tangible measures would follow. And this is where the wheat separates from the chaff. While some presented credible measures over a clear timeframe, others showed little willingness to change. 

Hand-picked selection

In Japan, we have invested more than half of the exposure in small companies. This is only possible with a meticulous balance sheet analysis and personal visits to thoroughly understand the company's objectives. Do they algin with our requirements? 

We don’t just broadly invest in the Japanese equity market, but in individual Japanese business models. As a result, the performance of our equity exposure can deviate significantly from major indices such as the Nikkei 225. With our current 66 equity positions, we hold less than 2% of all stocks traded on the Japanese stock exchange. Hand-picked access is therefore more than just a catchphrase. 

In closing, let me circle back to Japan as a vacation destination. My opinion: Japan is definitely worth a visit. You will appreciate the variety of activities, the politeness, cleanliness and high level of safety. Wonderful food, a no-tipping culture and reliable train connections add to the appeal.