By: Brett Moshal, Co-lead of the Japan team, Orbis Investments
Japan is the world’s second-largest developed stock market and home to over 600 companies with market values above US$1bn. But despite its size, Japan is often left hanging on the periphery of investor attention. We can see why. Since its epic bubble burst in 1990, the Japanese benchmark has returned less than 1% per year in US dollars, compared to 9% per year for other developed markets.
But while Japan has been a depressing market for passive investors, it has been a tremendous hunting ground for active stockpickers. In Japan, stocks classified as ‘value’ have beaten ‘growth’ stocks by 4% per year since 1975, far beyond the 1% per year value stocks have delivered in other global stock markets. The market’s cyclicality feeds big swings in greed and fear, providing a great setup for contrarians to exploit.
Contrarian stockpicking has worked even better than a simple ‘value’ approach, delivering globally competitive returns in part because doing our homework helps us avoid stocks that can look undervalued but remain cheap forever. There are plenty of such value traps in Japan. Unlike the rest of the world, the proportion of companies in Japan that trade below their book value is enormous, and many of them have traded at those low valuations persistently.
In recent years, Japanese institutions have made efforts to unlock some of that value, but progress had been slow. This year, the Tokyo Stock Exchange singled out companies whose shares trade at a price-to-book ratio (PBR) of less than 1.0, obliging them to tell investors of their plans to achieve a higher valuation. This has lit a fire under management teams and opened the door to greater shareholder activism. Some of our holdings had already started to improve. Megabanks like Sumitomo Mitsui Financial Group and Mitsubishi UFJ Financial Group continue to reduce inefficient crossholdings of other companies’ shares, have adopted progressive dividend policies, and have increased share buybacks.
Yet other companies could benefit greatly from self-help measures. Inpex, for example, is a cash-generating oil and gas producer whose valuation has languished at 0.6 times book value. Were Inpex to increase payouts in line with international peers, it could be rewarded with a far higher valuation. But the biggest reason we find Japanese shares attractive is the simplest one – their valuations. Despite its improving fundamentals, the Japanese market remains inexpensive versus other world stock markets, particularly the US. As is the case elsewhere, the gap in valuations between the cheapest and the most expensive stocks in Japan remains wide. When we look from the bottom up, we can find shares that are far cheaper than the Japanese market while still picking up a higher dividend yield.
With improving fundamentals and attractive valuations, Japan now represents 14% of the Orbis Global Equity Fund.