A marked increase in profitability is helping Japanese companies close the valuation gap between themselves and US, UK and European listed companies, says Asset Management One International, part of one of Japan’s largest fund managers with $495 billion in assets under management.
Expected returns on equity (ROE) for Japanese companies have jumped from below 9% last year to 10.5% this year rising in Japan. The 15-year average for the ROE, a key measure of profitability, for Japanese shares was 8.14%*.
For Japanese tech companies Asset Management One says that expected ROE has increased from 12% a year ago to over 14% now. Although Asset Management One says that is partly dependent on the duration of disruption in the Straits of Hormuz and its impact on oil prices.
Japan’s recovery from years of economic stagnation has boosted corporate profitability. At the same time, the governance reforms campaign led by the Tokyo Stock Exchange have made businesses much more capital efficient.
Rising interest rates, which can help the earnings of banks, has also boosted the ROE of financial services companies whose ROE has increased from approximately 6.4% five years ago to over 10% now.
Asset Management One says that the ROE achieved by Japanese companies has now deviated to such a degree from the long-term average that it is very possible that ROE for Japanese companies has entered a new upward trend.
Further corporate governance reforms due in June of this year should help. They are expected to focus on getting companies to deploy their excess cash productively – helping to improve ROE. Japanese companies have an average cash-to-assets ratios of 20.8%, which has been a drag on their ROE. In contrast, the average cash-to-assets ratio for US companies is just 7.9% and for European companies 8.7% (all ex-financials).
The new economic growth policies from Prime Minister Sanae Takaichi, which are due this summer, are likely to support corporate profitability. This, along with the increased focus amongst Japanese companies on shareholder value, will help close the gap in the price-to-book ratios (PBR) of Japanese companies and their UK, US and European competitors. PBR compares a company’s market capitalisation with their book value – a low PBR may suggest a company is undervalued.
Japanese shares have on average PBR of 1.77**, whereas their European, UK and US counterparts have a PBR of 2.32, 2.32 and 5.14 respectively. Globally, the average PBR is 3.71.
Oleg Kapinos, Head of Global Distribution Strategy at Asset Management One International explains: “The ROE for Japanese companies has been improving but there is still scope for further increases. That process should help close the significant valuation gap that still exists between Japanese equities and US and European markets.”
Japan developed a reputation for being a “value trap” during its decades of stagnation. However, the last five years have seen Japanese value shares recover strongly.
The strong performance of value stocks has enabled AMO’s Japan Value Equity fund to consistently outperform its benchmark, Topix, over the past three years. While Topix has returned 23.3% pa over that period, the fund has returned 30.5%.
Past performance is not a reliable indicator of future results.
* Data from MSCI, Fact Set
** MSCI Japan Index
