I have been happy to watch the markets rise for the past few months, but I must admit that I am running out of ideas for new investments in Europe and the UK. There are many stocks with the book value characteristics or P/S characteristics that I seek, but they do not have the returns or balance sheets that I am interested in.
The rally in the past few months has to my mind been a cyclical bull market rally in a secular bear market. I do not think that the great de-rating is over (particularly with regard to the average US quoted equity).
The Japanese market stands out as being different from many other stock market indices. Maybe the derating suffered by Japanese equities during their 20 year secular bear market is an image of the future for many other equity markets. Two blog posts this week by Neonomic and Valueandopportunity have reminded me to get off my ass and run some of my favourite and most trusted valuation screens for Japanese equities. Now just because a security has fallen for a prolonged period of time doesnt mean that it is now good value. Maybe the security was significantly overvalued in the first place (which was deinitely the case with Japanese equities at the end of the 1980’s). It is should be pointed out, that Japanese equities have proven to be a value trap for many value investors. There has been very no real discernable catalyst in a country where corporate governance is generally appauling.
Some of my ex colleagues who are responsible for http://www.valueinstitute.org/ have published two very interesting articles on Japanes corporate governance or the lack thereof:
My favourite Stock-Screens
I typically run 4 screens:
- P/B, gearing and RoE,
- Graham & Dodd PE,
- P/S, Current profit margin & 10 year average margin
- Net/Net Screen.
I use my stock-screeens to deliver a menu of delights that I typically like to dine on. From that menu, I then choose my victuals.
There are investors that are of the view that the human being is such an inferior investor that one should run scrrens that have a high probability of being successful and go long the stocks in the screen. While I agree with much of those sentiments, I do actually enjoy equity analysis, reading annual reports and building valuation models.
- Price/Book Screen
There are four parameters in my P/B screen and all are equally weighted.
- P/B less than 1
- RoE (latest FY)
- RoE (10yr avg)
- Debt/Equity Ratio
These criteria were used to screen the 400 largest equities in Japan,
Firstly some descriptive statistics from the aggregate 400 companies screened.
|RoE 10 yr avg||7.9%|
In a manner, this can be viewed as a valuation for the Japanese equity market. While the P/B ratio is low, so too is the current RoE and the ten year average RoE. If I were viewing this as a stock that on average delivered an 8% return, I would deduce that this type of return deserved a P/B ratio of no greater than unity.
Of the 400 stocks screended, 180 of them had a P/B ratio of 1 or below.
The 25 most interesting to me are listed below (some of them are pretty small).
|Ticker||Company||P/B||RoE||RoE 10y Avg||Gearing||Mkt Cap|
|3337||Circle K Sunkus||0.7||8.3||11.3||-47||109715|
|9945||Plenus Co Ltd||0.9||7||14.5||-38||50552|
|5423||Tokyo Steel Mnfg||0.6||-4.2||7.7||-4||87897|
|8031||Mitsui & Co Ltd||1||16.6||12.6||42||2385051|
- Net/Net screen
The net net filter is a particularly difficult screen in that it seeks to find stocks that trade at a discount to the value of Net Working Capital. In effect it is a seeking for stocks that are valued below the windown value of the company. The following stocks have a P/NetNet of 1x or lower:
- Graham & Dodd PE Screen
With the G&D PE screen I am seeking stocks where the Price to average earnings (over the past decade is low), preferrably single digit.
|Ticker||Company Name||MktCap||RoE(10yr)||PE 10|
|3337||Circle K Sunkus||109715||11.3||6.2|
|9945||Plenus Co Ltd||50552||14.5||6.2|
|6302||Sumitomo Heavy Ind||259279||14.5||8.3|
|5214||Nippon Elec Glass||333291||15.4||8.4|
|5713||Sumitomo Metal Mng||635064||13.5||8.9|
|5110||Sumitomo Rubber Ind||250796||11.5||9.6|
There are a surprisingly high amount of equities that are trading on low PE10 ratios that have reasonably decent returns and low leverage.
- Price/Sales Screen
The stocks that I have screened that have low P/S ratio, but that the historic margin seems to be undervalued by that valuation are listed below:
|Ticker||Company Name||MktCap||P/S||EBIT%||10yr Margin|
|3337||Circle K Sunkus||109715||0.5||10%||11.0%|
|7270||Fuji Heavy Inds||409637||0.3||5%||5.6%|
|9945||Plenus Co Ltd||50552||0.4||5%||6.9%|
The P/S screen is one that I like a lot. In general it gets much less attention than other value screens. The way I use this screen is to look at the P/S ratio and then compare current margins with historic average margins. I use a Gordon Growth type model adjusted for P/S as opposed to price to decide what is an appropriate multiple for a given level of profit margin at a static 10% cost of equity with 1% terminal growth assumption. This screen has helped me uncover many gems over many years. The idea is simple ~ as margins fall from the long term average the derating can be harsher than the margin decline. If margins are mean reverting and cyclical as opposed to the business model being impaired then one may have unearthed some treasure.
In truth I have never much enjoyed analysing or investing in Japan. There are many reason, from the poor state of many financial statements provided by companies to the fact that a lot of Japanese companies that I have looked at in the past seem to have pedestrian if not mediocre returns profiles. Then there is the corporate governance issue – however I do feel that Japan gets a poor rap here. Corporate governance in many European markets has been poor (but I do concede that it has improved notably in Germany and the Netherlands). It is my opinion that in many Spanish and Italian equities that corporate governance is not only poor, but simply non existant.
I do accept that I will not change how companies conduct business, nor is that my remit. So instead I will try and focus on what has worked for me in the past. In that regard, I was pleasantly surprised at the amount of companies that have above average returns and low valuations. A good many of these have little or no gearing on the balance sheet.
I am going to begin my analysis by looking at the telecoms operators (KDDI, NTT and NTT DoCoMo), for no other reason than they appear across all of my screens. In generaal I am wary of telco’s given that I believe they are deflationary and highly regulated. Being a bear on China, I wouldnt mind staying clear of Japanese companies that have a lot of export related exposure to China (particularly Steel). So in this regard, looking a domestic plays seems like a good place to begin (I may find out that these guys have a lot of foreign exposure).