As a country, Japan’s rocky ride through the global downturn has led some commentators to question the country’s future, while the long-term returns from the market have been variously disappointing or unimpressive for nearly two decades.
Should we follow the crowd and forget about investing in Japan? We do not think so.
The first thing to remember when people are (rightly) excited by emerging markets growth, is Japan is right next door to many of these fast-growing economies, and is well placed to benefit from their increased demand. Chinese imports of Japanese goods were up 40% year on year in December and half of Japanese exports now go to Asia.
Second, the Japanese market remains very large. There are over 3,000 listed companies in Japan large enough to invest in and Japan’s markets are in value terms roughly equivalent in size to China, Hong Kong, Indonesia, India, Korea, Malaysia, Philippines, Singapore, Thailand and Taiwan combined. This gives a lot of scope to find individual companies with good growth prospects.
Japanese companies still lead the world in many aspects of technology, and the rigorous approach to manufacturing excellence means it remains a key supplier of many high-end products. The accumulated body of knowledge, patents, and engineering “know-how” remains hugely valuable in a global context. We have found opportunities in global leaders such as Canon and Nintendo as well as in more service-orientated engineering companies that analysis suggests will be very difficult for competitors to displace. Additionally, there are a number of dynamic domestic growth businesses. For example, internet leaders such as Rakuten have an online shopping mall that is showing high rates of profit growth as it displaces traditional retailers.
Meanwhile, it is easy, but wrong, to assume the uninspiring returns of the past give a guide to the future. At the end of the 1980s, bubble valuations reached stratospheric levels, a starting point that was a major contributor to Japan’s prolonged underperformance. At the moment, the team is regularly able to find companies it thinks are valued on a P/E ratio in the single digits a few years out, often with substantial financial assets as an extra bonus.
I have just returned from an investment trip to Japan. Many companies have taken substantial steps to reduce fixed costs so margins could surprise in the upturn while there is a sense of cautious optimism that demand has bottomed. By focusing relentlessly on the competitive advantages and growth prospects of individual companies, the team believes it can continue to uncover attractive investment opportunities in Japan.
Matt Brett is an investment manager in Baillie Gifford’s Japan specialist team
