I think I’m Turning Japanese . . . (I really think so)*

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:

Lessonson Japanese Corporate Governance

Is Japan a Value Trap

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.

  1. P/B less than 1
  2. RoE (latest FY)
  3. RoE (10yr avg)
  4. 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.

P/B 1.18
RoE 8.0%
RoE 10 yr avg 7.9%
Gearing 30%

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
9997 Belluna 0.4 9.5 10.8 4 30025
8248 Nissen 0.7 18 15.6 4 18333
9433 KDDI Corp 0.9 17.2 15.2 37 2086797
3086 J. Front 0.8 4.4 13.4 22 195592
3337 Circle K Sunkus 0.7 8.3 11.3 -47 109715
9945 Plenus Co Ltd 0.9 7 14.5 -38 50552
9432 NTT 0.6 7.7 9.5 29 4802091
6498 Kitz 0.8 8.1 12.2 32 37355
5444 Yamato Kogyo 0.9 4.2 13.4 -33 168908
9435 Hikari Tsushin 0.9 1.2 13 1 108232
3088 Matsumotokiyoshi 0.8 10.3 11 14 78033
1951 Kyowa Exeo 0.7 6 9.5 3 74784
8219 Aoyama Trading 0.4 3 5.4 -16 87868
6804 Hosiden Corp 0.6 2 8 -43 38698
9749 Fuji Soft 0.6 4.9 7.8 40 46458
5423 Tokyo Steel Mnfg 0.6 -4.2 7.7 -4 87897
8060 Canon Marketing 0.5 2.9 6.4 -39 130737
3635 Tecmo Koei 0.8 5.1 10.2 -19 53940
8233 Takashimaya 0.8 3 10.1 20 193656
8031 Mitsui & Co Ltd 1 16.6 12.6 42 2385051
9370 Yusen Logistics 1 7.3 12 -41 47441
4812 Information Services 0.6 7.2 7 -1 20462
7862 Toppan Forms 0.7 4.7 8 -22 77625
4043 Tokuyama 0.6 5 6.8 14 102995
4182 Mitsubishi Gas 0.9 11.9 10 47 214703

 

  • 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:

Ticker Company Name P/NetNet
6804 Hosiden Corp 0.59
6349 Komori Corp 0.75
6751 Japan Radio 0.76
1973 NEC Networks 0.82
6839 Funai Electric 0.87
6986 Futaba Corp 0.88
8060 Canon Marketing 0.89
5901 Toyo Seikan 0.91
6581 Hitachi Koki 0.92
8130 Sangetsu 0.97
6134 Fuji Machine 1.01

 

  • 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
7202 Isuzu Motors 693003 41.7 3.8
8248 Nissen 18333 15.6 4.5
6460 Sega Sammy 387630 22.4 5.8
7201 Nissan Motor 3166634 18.9 5.8
9433 KDDI Corp 2086797 15.2 5.9
3086 J. Front 195592 13.4 6.0
2168 Pasona Group 27039 18 6.1
3337 Circle K Sunkus 109715 11.3 6.2
9945 Plenus Co Ltd 50552 14.5 6.2
9432 NTT 4802091 9.5 6.3
6498 Kitz 37355 12.2 6.6
5444 Yamato Kogyo 168908 13.4 6.7
9435 Hikari Tsushin 108232 13 6.9
3088 Matsumotokiyoshi 78033 11 7.3
1951 Kyowa Exeo 74784 9.5 7.4
3635 Tecmo Koei 53940 10.2 7.8
8233 Takashimaya 193656 10.1 7.9
7453 Ryohin Keikaku 103409 15.1 7.9
6302 Sumitomo Heavy Ind 259279 14.5 8.3
2685 Point 73425 33.7 8.3
9370 Yusen Logistics 47441 12 8.3
4902 Konica Minolta 323439 13.1 8.4
9766 Konami Corp 280587 13.1 8.4
5214 Nippon Elec Glass 333291 15.4 8.4
6366 Chiyoda Corp 226455 14.2 8.5
8058 Mitsubishi Corp 2928357 12.9 8.5
6448 Brother Industries 257210 14.9 8.7
4768 Otsuka 180475 15.8 8.9
5713 Sumitomo Metal Mng 635064 13.5 8.9
9437 NTT DoCoMo 5639513 13.4 9.0
4182 Mitsubishi Gas 214703 10 9.0
8242 H2O 119442 8.8 9.1
3391 Tsuruha 96741 12.1 9.1
6417 Sankyo (Machinery) 347676 10.9 9.2
6278 Union Tool 28971 8.7 9.2
4205 Zeon 157855 14 9.3
7267 Honda Motor 4992377 12.9 9.3
1928 Sekisui House 481769 8.6 9.3
9831 Yamada Denki 514387 12.8 9.4
6839 Funai Electric 60655 8.4 9.5
3101 Toyobo 99230 10.5 9.5
5110 Sumitomo Rubber Ind 250796 11.5 9.6
5108 Bridgestone Corp 1350876 10.4 9.6
8281 Xebio 85344 8.3 9.6
6383 Daifuku 49245 8.3 9.6
7261 Mazda Motor 256676 9.2 9.8
2871 Nichirei Corp 111982 10.2 9.8
7451 Mitsubishi Shokuhin 121889 11.2 9.8

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
9997 Belluna 30025 0.2 7% 7.6%
7248 Calsonic Kansei 123535 0.1 3% 3.4%
2168 Pasona Group 27039 0.1 2% 2.9%
9432 NTT 4802091 0.5 13% 13.8%
6498 Kitz 37355 0.4 6% 10.2%
1878 Daito Trust 543244 0.4 7% 9.4%
3337 Circle K Sunkus 109715 0.5 10% 11.0%
3088 Matsumotokiyoshi 78033 0.2 4% 4.2%
9719 SCSK 118147 0.5 5% 10.2%
2282 Nippon Meat 208456 0.2 4% 3.8%
7270 Fuji Heavy Inds 409637 0.3 5% 5.6%
6770 Alps Electric 111483 0.3 5% 5.3%
9945 Plenus Co Ltd 50552 0.4 5% 6.9%
6702 Fujitsu Ltd 819574 0.3 3% 5.1%
2678 Askul 37526 0.2 3% 3.3%
4043 Tokuyama 102995 0.5 7% 8.1%
8016 Onward Holdings 101217 0.4 5% 6.5%
9861 Yoshinoya Hldgs 54636 0.3 3% 4.7%
6724 Seiko Epson 205787 0.3 3% 4.5%

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.

Conclusion

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).

*Apologies to The Vapours

4 Responses to “I think I’m Turning Japanese . . . (I really think so)*”


  1. 1 Nate Tobik February 13, 2012 at 3:43 am

    Great post, I’ve come to a similar conclusion in the past.

    I took a dive and purchased four Japanese net-net’s this past year after the earthquake. It’s been a wild ride, but I ended the year flat one one, and up double digits on the rest. I sold out of one up 50% in about two months.

    I’ve been considering tip toeing back into the market again to pick up a few more net-net’s but I have the same feelings as you. Even though there is considerable value for some reason Japan is not all that interesting. I’d much rather look into a marginal investment in North America or Europe than reading through some net-cash companies in Japan.

    As strange as it may seem given my good experience I’m still wary of my money being stuck there. I went with net-net’s because I had seen some research (by Montier I think?) that showed that Japanese net-net’s had positive gains in pretty much any time period. I felt that since I don’t know the language buying with a considerable tangible margin of safety was the best defense against ignorance, or mistakes.

    If you’re interested I wrote up probably 5 Japanese net-net’s on my blog back in the spring (search the archives). A few of the stocks have done well, most are unchanged.

  2. 2 Richard Beddard February 13, 2012 at 3:02 pm

    Hi John. I don’t have any interest in Japanese stocks but thought I’d remark that you price/book screen is very similar to mine and I to use it as a menu of delights.

    >> 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. <<

    Couldn't have put it any better myself. Lord help us!

  3. 3 jmcelligott February 13, 2012 at 3:08 pm

    Yep. I think that we are beyond help. I will say though, that I also allow the quantitative element of screening to influence me. For example, I keep track of how many companies meet my strict criteria and whether or not those are clustered in certain stocks or countries. This is a great way of using screens as part of an overall value based startegy – and it has saved my bacon at several important peaks/troughs in the past decade.

    However, in order to actually purchase a stock, I would feel compelled to actually analyse and understand what it is I am buying – even if that means I have a higher rejection rate than the amount of stocks in my screens.

    I have rarely enjoyed analysing Japanese stocks in the past for reasons that I mentioned in the post. If I found that the market was good value then in all liklihood I would have purchased an ETF. But 1.18xBV for an investment that generates 8% ROE seems to be fair to slightly expensive to me.
    Anyway, thanks for the sentiments.


  1. 1 Market Musings 15/2/2012 « Philip O'Sullivan's Market Musings Trackback on February 15, 2012 at 1:41 pm

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