Daiwa Securities Group (OTCPK:DSEEY) is a $1.5 billion company that has a deep undervaluation as a result of being exposed to the Japanese economy. However, Japan looks like it is climbing out of its last 20 year hole with its huge economic stimulus program. Daiwa is poised to benefit from this stimulus as it operates as a securities broker dealer in Japan and internationally. I see this company as a multi-year investment opportunity.
Daiwa is the second largest securities firm in Japan (behind Nomura Holdings (NMR). Daiwa operates five business segments: retail, wholesale, asset management, IT/Think Tank and investments. Daiwa's services include: brokerage, trading, underwriting, strategic advice, product development and structured finance. The overall vision for Daiwa is to become Asia's leading financial services firm possessing and leveraging a solid business platform in Japan. It aims to establish a robust business structure capable of securing profit even under stressful economic conditions. The company also aims to achieve sustainable growth by linking Japan and the growth in Asia.
The company has a strategy to capitalize on the shift from saving to investment as it relates to each business segment. Daiwa aims to create a synergy between securities and banking services. It also aims to strengthen its wealth management business through inheritance related services.
Daiwa's deep undervaluation was created by Japan's low growth for the past two decades. Japan's stock market has performed poorly since 1990 and Daiwa has performed poorly along with it. However, this has created a compelling valuation and an exciting opportunity for investors. The company has a trailing PE ratio of 1.6, a price to sales ratio of 0.26, and a price to book ratio of 0.13. Daiwa's stock is trading at only 13% of its book value per share of $68.68. Since most stocks trade higher than their book value per share, Daiwa has some catching up to do. The price to book ratio for Japan's stock market is also low at 1.34 as indicated by the SPDR Russell/Nomura PRIME Japan ETF (JPP). If Daiwa's stock was trading with a price to book ratio of 1.34, the stock would be $92 instead of the current price of $8.74.
The current situation for Daiwa has created an asymmetric risk/reward scenario in favor of the positive side for the stock. Japan's commitment to stimulating its economy should put a floor under the stock. Japan is implementing a $1.4 trillion quantitative easing plan to be allocated by 2014. Japan's version of quantitative easing is 60% larger than the United States' QE plan. The "don't fight the Fed" philosophy has worked for the U.S. stock market, so there is no reason to believe that it won't work for Japan on this huge scale.
I see the possible downside risk for the stock as 10% - 15%. This would be in the form of a correction after the notable run-up in price this year. Fifteen percent below the current price puts the stock at $7.57 for the downside. Japan's QE program should put a floor under the stock, limiting the downside.
The likely upside potential is compelling. As Japan's economy recovers, Daiwa's business will perform well. Companies that make money will rise to reach their book value per share over time. Daiwa is a profitable company with a twelve-month EPS of $5.45.
Let's say that Daiwa's stock gets to just 50% of its book value per share by 2018. This means that the stock would reach $34. This would be about a 31% annual growth rate just for reaching half of its book value per share in five years. The total gain over five years would be 282%.
The large quantitative easing program in the U.S. has been positive for U.S. businesses and the U.S. stock market in the past few years. Japan's new large $1.4 trillion commitment to quantitative easing should bode well for Japan's businesses and stock market as well. Japan's QE program should help lower the value of the Yen, making the country's goods cheaper to obtain by other nations. The QE program should also help restore consumer confidence, which will allow the economy to step out of its double-decade rut. Daiwa stands to benefit as the company offers key financial services to the individuals and businesses that will reap the rewards of the stimulus program.
I think that Japan's massive QE program will improve the country's economy enough to increase consumer confidence, reinvigorate businesses, and bring renewed prosperity to the region. Daiwa is poised to benefit from the economic turnaround as individuals and business seek out its services. When combining this catalyst to a stock that has a deep undervaluation, vigorous price appreciation is inevitable.