Japanese Stocks - Where to Start?

[MrB]

MrB,

 

Are you avoiding US investments due to the fiscal cliff or the $69T in total obligations (unfunded pensions etc) to our $16T in GDP.  The US has onerous problems just like Japan but we keep most off the books.  I think we'd both agree that a liability both on or off the books is still a liability.

 

This isn't an attack or anything, I'm genuinely curious.  This is something I consider, should I be worried about my Dollar holdings?  If we look at the fiscal problems Japan's having and their predicted outcome a similar story could be painted about the US. 

No that is a fair question and the following is quoted from the first draft of a letter I’m putting together now, so consider yourself a guinea pig.

 

Firstly, in practical terms the removal of $600Bn from a $15,700Bn economy is hardly the end of the world. It is not inconsequential, but the world will not grind to a halt.

Secondly, $600Bn of debt on let’s call it a $16,000Bn debt pile is insignificant when measured against roughly $46,000Bn of total US tangible assets plus $141,000Bn of financial assets sloshing around American pockets. You can question how much of those tangible and financial assets are being double counted, but against that you have to also consider off balance sheet assets such as the “recently discovered” US gas assets unlocked by fracking. By some measures the annual oil/energy saving for the US can run to $600Bn/annum. The benefits are already being felt. Consider that from 2008-2012 US GDP grew from $14,200Bn to $15,700Bn yet net oil imports for the US decreased by 3.3m barrels per day to 7.8m barrels per day for an annual saving of around $100Bn.

Thirdly, you have US Fed that is clearly backing up its commitment to do what it takes with actions to the tune of $85Bn per month or $1,020Bn per annum, so I doubt they will let $600Bn spoil a good party.

What should concern us is that the US is currently spending 10% of “tax” revenues on interest while interest rates are at historical lows and the majority of the debt is very short term (even lower interest rates). Stimulus will not end until inflation forces the world to demand higher interest rates, which will force the Fed’s hand and lead to higher interest rates, which means your 10% could quickly become 20% and then you very, very quickly have serious problems.

 

So, for us Dec 2012, Jan 2013 and the foreseeable future will be business as usual, but we can hear the train coming.

 

I have a slightly different view to most on debt to GDP, because I think it is a bit like talking about Debt/Revenue for a company. Be as it may, I also think the US and Japan are in different positions both in the size of the problem and the immediacy. Japan’s issue is very large and with inflation just about guaranteed in the next few years their hand could be forced on interest rates very soon. Moving from sub zero interest rates to 2% while spending more than 20% of revenues on servicing your debt strikes me as a slightly comprising position. I am not advocating I know exactly how it will pan out in the medium term, but I am certainly not taking any currency risk. Hence my generalized question…do you hedge the currency? In light of the above I imply it might be a good idea.

So simply put: yes the US might have similar issues, but it ain’t tomorrow’s problem.

 

Another thought worth considering, Japan has almost no unemployment.  I'm willing to wager that almost every US senator and congressperson would double our debt to have the same unemployment that Japan has.  Just food for thought.

Correct, but Japan’s ROEs clearly show that it comes at a huge price. In fact it is a net cost, because from what I can tell Japan’s companies have ROEs below cost of capital. You can have full employment tomorrow in the US if you are able to convince all US companies to run with sub 8% ROEs. Note that I am purposefully avoiding putting numbers out on ROE, because it varies significantly depending who you listen to. Goldman Sachs estimated it to be 3.25% in 1995 and according to them it is now as high as 7%, but I question the methodology they are now using. My research indicates that it is now closer to the 1995 number than the latter.

 

In every part of the world there's risk, there's the macro risk in Europe, there's risk in the US, there's the house bubble in Canada, the China bubble.

As a value investor I'm looking at companies first not markets first.  The companies in Japan are priced as if it would be better if the whole of Japan completely closed up shop.  Japan's companies are already factoring in the fiscal destruction of whatever fate they might have, whereas US ones are not.  I'd argue that even Europe isn't all that cheap for their problems.  So if Japan does implode do companies go from 50% of BV to 10% of BV, or 1% of BV?  What's a good price?  I'm obviously concerned at some level about macro as well, I don't want to lose my money.  But I'm also not letting the macro drive my investment decisions, I know myself, I'm not a macro investor, I can analyze companies but not economies.

And that is not a bad philosophy to have. However I bet you will not invest in Iraq, Pakistan or maybe Nigeria. If not, why not? Japan has real well documented problems and not thinking about them does not make them go away. In this case it really is not that complicated and on a basic level you have a “new” BOJ very clearly saying that they will inflate…it is now or never… Personally I will not bet against that, I will put in the call to my broker to hedge the currency.

 

Just a thought experiment.  The market is saying that Japanese companies should liquidate, they are destroying shareholder value.  Yet Japan is a critical element in the global supply chain, and holds valuable assets and IP.  What if Japan did just close up, who would be affected?  Could US companies continue to function if there was no Japan? 

It is not a scenario I’m contemplating. Japan is not going away, unless they really cannot let the Spratley Islands go or whatever those islands are called they are fighting over.

I'm obviously concerned about losing my money, not just in Japan but everywhere.  I have hedged my Yen exposure on and off since investing over there.  Right now I'm exposed, but I'm considering buying some deep out of the money puts, a sort of catastrophe insurance.

Please note that I did not suggest Japan is not a place to invest. I said there are hurdles, I think, you need to overcome. We’ve had a long and happy experience investing directly in Japanese stocks. However, I think a critical ingredient is that we’ve always set exactly the same bar we set for US or any other company. Well run companies of which the pocket risk is as important as the fundamental investment risk. I’m simply not prepared to invest in a low ROE company even if it has a high cash component if my partner is sitting on that money until the cows come home. Offering that company to me at a fraction of its cash does not change my mind.

 

In conclusion: Is the JGB market in bubble territory? Is the stock market generally depressed? Will inflation cause the JGBs to deflate? If so where does the cash go? Interesting thought.

 

[oddballstocks]

MrB,

 

Are you avoiding US investments due to the fiscal cliff or the $69T in total obligations (unfunded pensions etc) to our $16T in GDP.  The US has onerous problems just like Japan but we keep most off the books.  I think we'd both agree that a liability both on or off the books is still a liability.

 

This isn't an attack or anything, I'm genuinely curious.  This is something I consider, should I be worried about my Dollar holdings?  If we look at the fiscal problems Japan's having and their predicted outcome a similar story could be painted about the US. 

No that is a fair question and the following is quoted from the first draft of a letter I’m putting together now, so consider yourself a guinea pig.

 

Firstly, in practical terms the removal of $600Bn from a $15,700Bn economy is hardly the end of the world. It is not inconsequential, but the world will not grind to a halt.

Secondly, $600Bn of debt on let’s call it a $16,000Bn debt pile is insignificant when measured against roughly $46,000Bn of total US tangible assets plus $141,000Bn of financial assets sloshing around American pockets. You can question how much of those tangible and financial assets are being double counted, but against that you have to also consider off balance sheet assets such as the “recently discovered” US gas assets unlocked by fracking. By some measures the annual oil/energy saving for the US can run to $600Bn/annum. The benefits are already being felt. Consider that from 2008-2012 US GDP grew from $14,200Bn to $15,700Bn yet net oil imports for the US decreased by 3.3m barrels per day to 7.8m barrels per day for an annual saving of around $100Bn.

Thirdly, you have US Fed that is clearly backing up its commitment to do what it takes with actions to the tune of $85Bn per month or $1,020Bn per annum, so I doubt they will let $600Bn spoil a good party.

What should concern us is that the US is currently spending 10% of “tax” revenues on interest while interest rates are at historical lows and the majority of the debt is very short term (even lower interest rates). Stimulus will not end until inflation forces the world to demand higher interest rates, which will force the Fed’s hand and lead to higher interest rates, which means your 10% could quickly become 20% and then you very, very quickly have serious problems.

 

So, for us Dec 2012, Jan 2013 and the foreseeable future will be business as usual, but we can hear the train coming.

 

I have a slightly different view to most on debt to GDP, because I think it is a bit like talking about Debt/Revenue for a company. Be as it may, I also think the US and Japan are in different positions both in the size of the problem and the immediacy. Japan’s issue is very large and with inflation just about guaranteed in the next few years their hand could be forced on interest rates very soon. Moving from sub zero interest rates to 2% while spending more than 20% of revenues on servicing your debt strikes me as a slightly comprising position. I am not advocating I know exactly how it will pan out in the medium term, but I am certainly not taking any currency risk. Hence my generalized question…do you hedge the currency? In light of the above I imply it might be a good idea.

So simply put: yes the US might have similar issues, but it ain’t tomorrow’s problem.

 

Another thought worth considering, Japan has almost no unemployment.  I'm willing to wager that almost every US senator and congressperson would double our debt to have the same unemployment that Japan has.  Just food for thought.

Correct, but Japan’s ROEs clearly show that it comes at a huge price. In fact it is a net cost, because from what I can tell Japan’s companies have ROEs below cost of capital. You can have full employment tomorrow in the US if you are able to convince all US companies to run with sub 8% ROEs. Note that I am purposefully avoiding putting numbers out on ROE, because it varies significantly depending who you listen to. Goldman Sachs estimated it to be 3.25% in 1995 and according to them it is now as high as 7%, but I question the methodology they are now using. My research indicates that it is now closer to the 1995 number than the latter.

 

In every part of the world there's risk, there's the macro risk in Europe, there's risk in the US, there's the house bubble in Canada, the China bubble.

As a value investor I'm looking at companies first not markets first.  The companies in Japan are priced as if it would be better if the whole of Japan completely closed up shop.  Japan's companies are already factoring in the fiscal destruction of whatever fate they might have, whereas US ones are not.  I'd argue that even Europe isn't all that cheap for their problems.  So if Japan does implode do companies go from 50% of BV to 10% of BV, or 1% of BV?  What's a good price?  I'm obviously concerned at some level about macro as well, I don't want to lose my money.  But I'm also not letting the macro drive my investment decisions, I know myself, I'm not a macro investor, I can analyze companies but not economies.

And that is not a bad philosophy to have. However I bet you will not invest in Iraq, Pakistan or maybe Nigeria. If not, why not? Japan has real well documented problems and not thinking about them does not make them go away. In this case it really is not that complicated and on a basic level you have a “new” BOJ very clearly saying that they will inflate…it is now or never… Personally I will not bet against that, I will put in the call to my broker to hedge the currency.

 

Just a thought experiment.  The market is saying that Japanese companies should liquidate, they are destroying shareholder value.  Yet Japan is a critical element in the global supply chain, and holds valuable assets and IP.  What if Japan did just close up, who would be affected?  Could US companies continue to function if there was no Japan? 

It is not a scenario I’m contemplating. Japan is not going away, unless they really cannot let the Spratley Islands go or whatever those islands are called they are fighting over.

I'm obviously concerned about losing my money, not just in Japan but everywhere.  I have hedged my Yen exposure on and off since investing over there.  Right now I'm exposed, but I'm considering buying some deep out of the money puts, a sort of catastrophe insurance.

Please note that I did not suggest Japan is not a place to invest. I said there are hurdles, I think, you need to overcome. We’ve had a long and happy experience investing directly in Japanese stocks. However, I think a critical ingredient is that we’ve always set exactly the same bar we set for US or any other company. Well run companies of which the pocket risk is as important as the fundamental investment risk. I’m simply not prepared to invest in a low ROE company even if it has a high cash component if my partner is sitting on that money until the cows come home. Offering that company to me at a fraction of its cash does not change my mind.

 

In conclusion: Is the JGB market in bubble territory? Is the stock market generally depressed? Will inflation cause the JGBs to deflate? If so where does the cash go? Interesting thought.

 

Thank you for the response, it's appreciated.  I think inflation is coming at some point as well, and the more I think about Japan the more I think I need to hedge some or all of my currency risk.

 

The difference with Iraq/Nigeria/Pakistan is there's also political and stability risk.  Japan is a first world country whereas in Nigeria there could be a military coup next week.  It's possible in Japan, but about as likely as a military coup in England.

 

You have some good points on the ROE, although some of the ROE's are misleading.  If you back out the excess cash at a lot of these companies ROE's improve to more normal levels.  I've been looking at net-nets and net-cash companies and one of my metrics is ROE ex-cash.  There are some in the 10-15% range, so the actually business is decent, it's just masked by the overcapitalization.  Of course there are slews of 2-3% ROE companies ex-cash as well.

 

I'm not as much of a good company at a good price investor, I do better with deep value and cigar butts.  For solid compounders there are probably just as many in Japan as anywhere else, although I'm not sure how cheap they are.  I've found a number of higher quality companies selling at lower prices in Europe.

 

The pocket risk is real and if the currency drops that high cash holding suddenly isn't as valuable either.  My first pass at Japan I was looking for the safest absolute bargains, the net-cash companies.  As I've been looking at companies and investing in net-nets over there I've changed my approach a lot.  I'm not looking for severe undervaluations on acceptable companies.  I'm looking for high FCF yields, no debt, and an ok ROE ex-cash.  A dose of foreign sales exposure is also helpful.  It seems like I'm looking for the impossible, but with how cheap Japan is I'm finding companies that meet my criteria.  I should also note, I started with net-nets because it was a good starting point for balance sheet safety, but I would probably take a better company at just a book value discount to simply a discounted pile of cash.

 

But even with the net-nets there are success stories.  Sonton Foods, and Noda Screen both went private in management led buyouts.  Sonton Foods at a 60+% premium, Noda at a 100% premium to trading prices earlier in the year.

 

 

[zippy1]

Japanese government actually contracted a girl band to sell its bond. I can't stop wondering whether they have run out of buyers.  oh, hope you enjoy the video

[MrB]

You have some good points on the ROE, although some of the ROE's are misleading.  If you back out the excess cash at a lot of these companies ROE's improve to more normal levels.  I've been looking at net-nets and net-cash companies and one of my metrics is ROE ex-cash.  There are some in the 10-15% range, so the actually business is decent, it's just masked by the overcapitalization.  Of course there are slews of 2-3% ROE companies ex-cash as well.

 

Are you giving due consideration to the assumptions you are taking on board when backing out the cash? The obvious assumption would be that a. management will turn that cash into producing assets very soon or b. it will soon be returned to the investor. Well soon depends on the discount rate you are using and the price you are paying, so we could be talking 5 to 10 years in some cases. Nonetheless I would just make sure that the assumptions do not undermine the economic reality of the investment.

[Guest ajc]

 

I just found a write-up from last year on Kewpie (Tokyo: 2809) - "Japan's Heinz" - by Koon Boon Kee, that might be worth looking at for anyone who is interested in Japanese securities.

 

http://www.beyondproxy.com/kewpie/

 

 

 

[randomep]

You have some good points on the ROE, although some of the ROE's are misleading.  If you back out the excess cash at a lot of these companies ROE's improve to more normal levels.  I've been looking at net-nets and net-cash companies and one of my metrics is ROE ex-cash.  There are some in the 10-15% range, so the actually business is decent, it's just masked by the overcapitalization.  Of course there are slews of 2-3% ROE companies ex-cash as well.

 

Are you giving due consideration to the assumptions you are taking on board when backing out the cash? The obvious assumption would be that a. management will turn that cash into producing assets very soon or b. it will soon be returned to the investor. Well soon depends on the discount rate you are using and the price you are paying, so we could be talking 5 to 10 years in some cases. Nonetheless I would just make sure that the assumptions do not undermine the economic reality of the investment.

 

ooooooook, let's not back out the cash, what if I told you there is a Japanese company that has growing earnings, 8% ROE, sells for significantly less than netnet?

 

If that company was in the US I think it would sell for double......

 

Every economy has its quirks, but I think the disgust and prejudice with the Japanese economy has caused people to be very subjective when looking at Japanese companies. I think SOME Japanese companies are very mispriced, but that's my opinion and the market is all about us betting on our opinions right?

 

BTW the company is covered in my blog, cheers:

 

bovinebear.blogspot.com/search/label/Tachibana

[yadayada]

not sure if this is mentioned, but what about hedging against inflation of the yen? How expensive? Best way? When to do it?

[randomep]

not sure if this is mentioned, but what about hedging against inflation of the yen? How expensive? Best way? When to do it?

 

Hedging has been on my mind but I really don't know how. You can buy or sell Yen futures but then are in blocks of $100k USD. But let's say you have $100k invested in Japan, you can sell the futures. These futures are available a few months or a year out or maybe more. But if you do that I feel you aren't hedging you are actually magnifying the currency effect. Let me explain.

 

For the last year, the yen has fallen, this has caused the market to go up, so the market and yen move in tandem. The yen has a dampening effect on the market return for us thinking in USD. I figure I gained 50% on stocks in yen but only 30% in USD.

 

But if you sell yen futures, in that case, then your gains would be magnified by the futures gains. On the flip side though, if the yen rises, then the market drops, and your futures value drops, you are screwed.

 

So I think I'll just leave my stocks as it is unhedged.

 

BTW, does anyone know of how to hedge in smaller quantities than $100K usd? for any currency?

 

thanks

[fareastwarriors]

not sure if this is mentioned, but what about hedging against inflation of the yen? How expensive? Best way? When to do it?

 

Hedging has been on my mind but I really don't know how. You can buy or sell Yen futures but then are in blocks of $100k USD. But let's say you have $100k invested in Japan, you can sell the futures. These futures are available a few months or a year out or maybe more. But if you do that I feel you aren't hedging you are actually magnifying the currency effect. Let me explain.

 

For the last year, the yen has fallen, this has caused the market to go up, so the market and yen move in tandem. The yen has a dampening effect on the market return for us thinking in USD. I figure I gained 50% on stocks in yen but only 30% in USD.

 

But if you sell yen futures, in that case, then your gains would be magnified by the futures gains. On the flip side though, if the yen rises, then the market drops, and your futures value drops, you are screwed.

 

So I think I'll just leave my stocks as it is unhedged.

 

BTW, does anyone know of how to hedge in smaller quantities than $100K usd? for any currency?

 

thanks

 

Currency ETFs

[PatientCheetah]

For those with longer term experience with Japanese stocks, how were the distribution of your returns like? Was it more or less random based on each companies' own fundamentals? Did them cluster like the case of last year?

[frank]

not sure if this is mentioned, but what about hedging against inflation of the yen? How expensive? Best way? When to do it?

 

Hedging has been on my mind but I really don't know how. You can buy or sell Yen futures but then are in blocks of $100k USD. But let's say you have $100k invested in Japan, you can sell the futures. These futures are available a few months or a year out or maybe more. But if you do that I feel you aren't hedging you are actually magnifying the currency effect. Let me explain.

 

For the last year, the yen has fallen, this has caused the market to go up, so the market and yen move in tandem. The yen has a dampening effect on the market return for us thinking in USD. I figure I gained 50% on stocks in yen but only 30% in USD.

 

But if you sell yen futures, in that case, then your gains would be magnified by the futures gains. On the flip side though, if the yen rises, then the market drops, and your futures value drops, you are screwed.

 

So I think I'll just leave my stocks as it is unhedged.

 

BTW, does anyone know of how to hedge in smaller quantities than $100K usd? for any currency?

 

thanks

 

Try the e-mini futures... for yen, the IB symbol is J7.  The per contract notional is only half of that is required for the regular yen.usd futures

[frank]

For those with longer term experience with Japanese stocks, how were the distribution of your returns like? Was it more or less random based on each companies' own fundamentals? Did them cluster like the case of last year?

 

Can't speak for others but I can share my results... I started to look into Japan in late-2011, mainly a net-net investor to begin with... '12 return was in the mid-single digits, '13 was close to 50 pct, and '14 so far this year is about -1%.  All of these are USD returns and I run a fully-hedged portfolio since 2013 and will sometimes go short the Yen (again, my definition of shorting the yen is to have a net short currency exposure meaning my short yen futures notional > my long JPY stocks notional).  My portfolio was heavily tilted towards net-nets and at one point I held close to three dozens net-nets and most of them profitable companies with quite predictable earning streams.  Had drastically reduced my exposure to net-nets nowadays as the most have appreciated in value and I needed liquidity.  Perhaps I have gone off topic a little bit but what I found from my experience on these micro-cap net-nets is that without a clear catalyst they tend to trade more like a convertible bond and have wide bid-ask spreads.  Sometimes they may run up for no reason but often times they will only run after a nice earnings beat. Otherwise they will just fluctuate and slowly appreciate in value in line with the cash build.  This is why I say they are like convertibles, they are stable but less exciting than the commons.  Like many who had invested in the space have said before, patience is indeed key for investing in these and when you see a clear catalyst you are OK to bet big IMHO.  One won't do too bad overall but don't expect great results unless you are nearing the end of a bull cycle.  Looking back though, I would rather buy into the liquid and high quality names first after a market panic as they are more sought-after and often priced more appropriately.

 

On returns from others, you may want to look into Symphony Financial Partners (http://www.symphony-fp.com).  They are a notable activist value fund in Japan and sometimes they will own some of the net-net names that smaller guys like us own.  I think their return is like 57% net of fees from Sept 2003 through end of May 2012 versus a decline of ~5% for the Nikkei according to this article (http://www.bloomberg.com/news/2012-05-30/ex-goldman-trader-run-symphony-seeks-1-billion-for-hedge-funds.html).  Last year was a home run year for them and for almost everyone who invested in Japan I am sure.  But in general, I think Japan was not the best market to be in for the last decade and their stock market so far still lags the other major developed markets in recovering from the 2008 financial crisis.

[PatientCheetah]

frank, thank you for the insights. I also come to the same conclusion that 2013 is anomaly. For a country that needs to import most of its basic needs, devaluation is a dangerous path to continue for an extended period of time. Its government lacks the fiscal flexibility to do much on its own and its corporations have shifted large portions of their assets overseas. Once Abe fails its enact his third arrow, I am not sure how much Japan has changed.

 

What Japan really needs to do is to reset its social safety net to realistic levels and tell its retirees that the government bonds need to take a large haircut. But this is tantamount to political suicide and won't happen anytime soon.

[fareastwarriors]

Activist Investors in Japan Find Some Doors Cracking Open

 

Friendly Approach Finds More Takers as Companies Seek to Heed Shareholders; ‘Aha’ Moments

 

http://www.wsj.com/articles/activist-investors-in-japan-find-some-doors-cracking-open-1422553369?mod=WSJ_hp_LEFTWhatsNewsCollection

[cobafdek]

One JASDAQ net-net I like and recently purchased is Odawara Engineering. Sales and earnings have been growing, business is getting better yet they still trade in the dumps.

 

Thanks, Nate.  This one (ticker 6149:JP) entered my basket of Japanese net-nets 2 years ago at 633 yen, and is the first one sold, for 1319 yen earlier this week.  Before the sale, my collection showed a 9% return since then.  During these two years, the dollar/yen has done a round-trip, and there was much hand-wringing on this board when the yen fell 20% in the interim, but as of today, the currency has not been a factor in the stock return.  I'm planning at least 2-3 more years of holding on to rest of the basket.

 

I have no explanation for the recent run-up in this stock, and I haven't tried very hard to find it out.  Any Japan investors have any good clues?