Japan’s good value creates alpha opportunities

Japan’s companies are among some of the most cash rich, globally. Equally, some of the most attractive developed market valuations are to be found in Japan. Investors willing to look beyond the economic headlines will discover a market of stocks that is attractive on many fronts.

Japan is typically perceived as a low growth economy with a rapidly ageing population, both of which keep the lid on domestic consumer spending. The country’s ability to attract investors thus has been low since its stock market hit an all-time high in 1989. Yet Japan has always been a corporate, not an economic, revival story. There is a very compelling corporate reform revival story that is ongoing.

Another key point to note is that Japanese corporates have remained resilient despite the pandemic. Gradual but steady corporate restructuring over the last decade has resulted in higher operational efficiency and improved trend profitability. This is fairly well known but is yet to be fully recognised by international investors. We expect the benign impact of the reforms to continue, justifying a strategic allocation to Japan equities in portfolios.

Thanks for subscribing!

Follow us :

Japan’s corporates demonstrate earnings resilience

We think that Japanese corporates have shown significant earnings resilience in recent years – with Topix EPS outperforming S&P and MSCI Europe EPS over 10 years. This is no small feat given the scale of financial engineering going on in US corporates! Examples of proactive policy that have boosted earnings include restructurings, where excess capacity has been taken out in steel and autos companies, and a focus on pricing, for example in beer and beverages.

Many companies exceeded the earnings expectations in 1Q22 (e.g., Nippon Steel, MMC, Mazda, Honda, Credit Saison) and delivered growth even in difficult conditions i.e., China lockdowns and raw material price hikes. Production is yet to normalise in the auto value chain given the negative impact in 1Q22. Furthermore, Japan’s Covid-related economic reopening is still unfolding versus the rest of the world in areas such as rail transport and domestic consumption. All this points to Japanese companies being much more immune to a global slowdown than investors are currently pricing in.

At 12x price-to-earnings ratio, Japanese equities are cheap both versus its own history and other developed markets; Europe is on a similar valuation multiple to Japan but has neither the earnings resilience of Japan nor the longer-term structural tailwinds. See Fig 1. With significant corporate governance reforms and a gradual shift in mindset towards profitability, margins have been expanding and return on equities (ROEs) have been improving. Abenomics kick-started the market reform process, but we believe that current Prime Minister, Fumio Kishida, will continue to back corporate reforms and these structural changes have another five to ten years to play out.

Fig 1. Japan is cheap compared to global peers

japans-good-value-creates-alpha-opportunities-Fig1

After an initial frenzy in 2013-15, international investors have largely shied away, and Japanese equities remain chronically under-owned in foreign portfolios. This is different from what one might expect when you consider the earnings per share trajectory over the last decade. See Fig 2. Furthermore, Japan is the only major market in positive territory year-to-date (in local currency terms) and we expect to see international investors return to the fray as they reallocate away from their US equities’ overweights.

Fig. 2. Japan’s earnings per share is on the rise

japans-good-value-creates-alpha-opportunities-Fig2

Why invest in Japan value

Growth stocks in Japan never quite traded at the extreme levels that we saw in the US, but we still observed relative valuations of growth versus value reach multi-decade highs. There has been a pullback year-to-date in the multiple that investors are willing to pay for growth and a positive re-rating for value companies, especially in certain sectors.

The price-to-book valuation multiple differential between growth and value stocks has thus closed slightly but remains at high levels. See Fig 3. However, after years of cheap companies being neglected, we think this trend has persistence as investors refocus on areas of the market where mispricing is prevalent.

Fig 3. Growth stocks continue to be valued higher than value

japans-good-value-creates-alpha-opportunities-Fig3

Our recent analysis on how much historical earnings growth has been delivered by companies in the MSCI Japan Value index versus the MSCI Growth Index too revealed an interesting result. Over the last five years, value companies have seen their earnings grow faster than growth companies. This suggests that the very reason to invest in the growth segment of the market turns out to be a bit of a fallacy.

Our sweet spot has always been to invest in companies where trend earnings are not properly reflected in prevailing share prices, and we believe this will continue to deliver strong outperformance through a market cycle. It is also worth noting that based on analysis done by BofA, value has outperformed the market in six out of eight recessions since the 1980s.

Opportunity to reap double digit returns

Japan remains a very cheap equity market versus global peers, and we expect the gap to narrow. In addition to continued earnings per share growth, dividend growth, and ultimately higher return on equity, any multiple re-rating would be a cherry on top for investors.

Ultimately there’s lots of opportunity for double digit returns for investors in Japan over the coming years. This is predominantly from 1) more efficient balance sheets/capital allocation, 2) improved margins from high pricing, costs efficiencies and culling underperforming products, 3) corporate governance reform being more friendly to shareholders, and 4) potentially a stickier inflationary environment.

Investors who remain skeptical on Japan risk missing out on long-term gains.

How to invest in Eastspring's fund(s)

Sources:
1 Credit Suisse estimates. Ministry of Commerce. 11 January 2022.
2 Confederation of Indian Industry.
3 Morgan Stanley Research. Capex Monitor – Tracking Macro and Micro indicators. 11 July 2022.

This document is produced by Eastspring Investments (Singapore) Limited and issued in:

Singapore and Australia (for wholesale clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore, is exempt from the requirement to hold an Australian financial services licence and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Australian laws.

Hong Kong by Eastspring Investments (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.


Indonesia by PT Eastspring Investments Indonesia, an investment manager that is licensed, registered and supervised by the Indonesia Financial Services Authority (OJK).


Malaysia by Eastspring Investments Berhad (531241-U).


This document is produced by Eastspring Investments (Singapore) Limited and issued in Thailand by TMB Asset Management Co., Ltd. Investment contains certain risks; investors are advised to carefully study the related information before investing. The past performance of any the fund is not indicative of future performance.


United States of America (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is registered with the U.S Securities and Exchange Commission as a registered investment adviser.


European Economic Area (for professional clients only) and Switzerland (for qualified investors only) by Eastspring Investments (Luxembourg) S.A., 26, Boulevard Royal, 2449 Luxembourg, Grand-Duchy of Luxembourg, registered with the Registre de Commerce et des Sociétés (Luxembourg), Register No B 173737.


United Kingdom (for professional clients only) by Eastspring Investments (Luxembourg) S.A. - UK Branch, 10 Lower Thames Street, London EC3R 6AF.


Chile (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Chilean laws.


The afore-mentioned entities are hereinafter collectively referred to as Eastspring Investments.


The views and opinions contained herein are those of the author on this page, and may not necessarily represent views expressed or reflected in other Eastspring Investments’ communications. This document is solely for information purposes and does not have any regard to the specific investment objective, financial situation and/or particular needs of any specific persons who may receive this document. This document is not intended as an offer, a solicitation of offer or a recommendation, to deal in shares of securities or any financial instruments. It may not be published, circulated, reproduced or distributed without the prior written consent of Eastspring Investments. Reliance upon information in this posting is at the sole discretion of the reader. Please consult your own professional adviser before investing.


Investment involves risk. Past performance and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the funds managed by Eastspring Investments.


Information herein is believed to be reliable at time of publication. Data from third party sources may have been used in the preparation of this material and Eastspring Investments has not independently verified, validated or audited such data. Where lawfully permitted, Eastspring Investments does not warrant its completeness or accuracy and is not responsible for error of facts or opinion nor shall be liable for damages arising out of any person’s reliance upon this information. Any opinion or estimate contained in this document may subject to change without notice.


Eastspring Investments (excluding JV companies) companies are ultimately wholly-owned/indirect subsidiaries/associate of Prudential plc of the United Kingdom. Eastspring Investments companies (including JV’s) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America or with the Prudential Assurance Company, a subsidiary of M&G plc (a company incorporated in the United Kingdom).