Japanese Stocks Look Different—and Better—Than in the 1980s

Nikkei stock prices displayed in Tokyo last week. PHOTO: ISSEI KATO/REUTERS
Nikkei stock prices displayed in Tokyo last week. PHOTO: ISSEI KATO/REUTERS

Summary

This time the U.S. market is dominated by bubbly growth stocks, while Japan offers a compelling alternative

The last time investors were really salivating over Japanese stocks, the Walkman was still a thing and headbands were essential fashion accessories. But with the Nikkei 225 finally crossing its high of 34 years ago, Japan is getting more attention from foreign investors again.

The particularly good news for U.S. investors itching to go beyond familiar shores is that value stocks have been the winning strategy in Japan—more or less the complete inverse of the U.S., where growth rules the roost. That adds up to a potentially useful diversification opportunity—especially since the trends driving Japan’s value outperformance don’t have much to do with the U.S., or even the cyclical performance of the Japanese economy itself, which just dipped back into recession.

In 1989, it was Japan that was the growth champion. Its economy was booming, and its companies were making waves around the globe. Not any more. But that hasn’t held back its market’s performance. The Topix index, considered more representative than the Nikkei, has more than doubled in the past decade.

 

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And value stocks have been in vogue, especially in recent years. Total returns from the MSCI Japan Value Index have outperformed the Japan Growth Index by around 40 percentage points in the past three years, in dollar terms. Even on a 10-year horizon, Japanese value stocks have beaten growth stocks by around 10 percentage points. The MSCI USA Growth index, on the other hand, outperformed the value index by nearly 200 percentage points in the past 10 years, in terms of total returns.

Corporate profits have done well lately partly thanks to the weak yen. For Japanese companies that had reported their results as of Feb. 9, recurring profits for the December quarter rose 18% year on year excluding SoftBank, which booked big gains from its technology investments, according to Goldman Sachs.

But a bigger reason the market has excelled is that Japanese companies are increasingly on board with the corporate-governance initiatives kick-started under then-Prime Minister Shinzo Abe. The Tokyo Stock Exchange has encouraged companies to take steps to improve depressed valuations, including indirectly naming and shaming those companies that haven’t come up with a capital efficiency plan.

Shareholders’ returns have indeed been rising. In the past decade, the number of buybacks announced by Japanese companies has tripled, and the number of strategic shareholdings has declined by 20%, according to JPMorgan. Bloated balance sheets with excessive cash and cross-shareholdings have been one major drag on valuations. Around 40% of the companies listed on the Tokyo Stock Exchange’s Prime Market trade below their book value. That is down from 50% a year earlier, but still leaves much room for improvement.

Even the world’s most famous value investor has joined the party. Warren Buffett has made a killing from investing in five Japanese trading companies—stodgy conglomerates with businesses ranging from mining to retail—in recent years. These companies are a classic value play—trading at low multiples with high dividend yields. Or at least they were when Buffett first bought them.

There are still real pockets of growth in the Japanese market: semiconductor equipment manufacturers or game makers, for example. But the real attraction for many is the market’s cornucopia of other, often-ignored stocks with low valuations—and the potential for higher returns.

That should be music to American stock pickers’ ears, especially those worried that the rally at home looks more like the Japan of yesteryear.

Write to Jacky Wong at jacky.wong@wsj.com

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