Investing In Japan

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Includes: HGJP, JSC, RPXC, YHOO
by: Brian Grosso

Summary

In July, I made the case to be cautious with US equities and take action, but I did not offer great alternatives then.

Since then, I've found bottom-up investing in small-cap value Japanese stocks to be a compelling alternative.

This article makes the case for Japan from a foreigner's perspective and introduces a few of the Japanese stocks I own in my basket.

In July, I wrote an article titled A Time to Act Fearful in which I made the case to be very cautious with US stocks. I felt and still feel that US stocks are highly valued and that it is extremely difficult to find compelling investment opportunities here. If you look hard enough there are stocks that could do very well, but the value is not at all obvious and the risk/reward does not look great because we are at a time of many peaks. For example, US M&A activity is at record levels right now. There are stocks levered to M&A activity that look really good right now in status quo scenarios, but not so great if you consider the risk of M&A activity declining in a market and/or economic downturn. Oddly, I'm finding this to be the case even in small-cap value stocks that you'd think would be more neglected. It just feels like too many dollars chasing too little intrinsic value.

So what to do about it? In the original article I made a point that knowing the market is overheated means nothing if you don't act on that knowledge, hence the title. I left it open-ended then because I was still thinking it through, but mentioned holding cash, paying down margin or personal debts, and a few other options. Since the article was published, I have held a good chunk of cash, but I am beginning to doubt that this is a good idea. I've seen some research since then suggesting that staying fully invested generally outperforms holding cash. More importantly, it's just not that feasible as an investment manager. People don't pay an asset-based fee for you to hold cash in their accounts.

This article serves as an update in which I offer what I think is a much better option: investing in individual stocks through bottom-up research in Japan and possibly other cheap markets.

#1 - Questioning the US

For a long time, I never even considered investing overseas. It didn't even seem like a question. The US market is what I know. US stocks have outperformed international stocks by a wide margin in the past and that will certainly continue because governance is better in the US, the regulatory environment is more pro-business, capitalism is stronger here, we've got a big ol' army, and as individuals we're smarter, more creative, and are just awesome in general. Right? Right? I'm not so sure. It's easy to think that's the case, but extrapolating US outperformance to infinity is dangerous. I strongly recommend readers check out the Credit Suisse 2015 Investment Returns Yearbook. The discussion is good, but even better is the immense data - 115 years of market data for over 20 of the world's largest markets. Take a look at these charts from page 35 showing the changes in the relative size of various equity markets from 1900 through the end of 2014:

115 years of equity outperformance in the US has not happened in isolation. The relative size of the US market has gone from 15% to 52%. That's right, more than half of global equity value is now in US markets. The question then becomes: where do you go from there? Can the US markets continue to take a bigger and bigger piece of the pie? This is a very difficult question. It's not an easy no. That 52% does not mean that 52% of global public equity value is being placed on corporate profits from the US. The reason is that many US-domiciled companies traded on US exchanges don't just get revenue and profits from the US. In an increasingly global economy, individual companies are becoming global too. I found a few different numbers, but this source has 1/3 of S&P 500 revenue coming from outside the US.

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Source: Business Insider

The S&P 500 is composed disproportionately of the largest US equities, so the percentage of revenue and profits for all US equities coming from outside the US is likely less than 33%, but still substantial. Are we moving toward a future where the biggest and best companies domicile and list in the US, but make money globally? Where US equity markets will continue to increasingly dominate globally? I'm not sure, but if history is any indication, there's still reason to worry about US markets. Two notable largest-market precedents from the data have underperformed subsequent to having the title. In 1900, UK markets were the largest in the world at 25%. Prior to 1900, they were probably much, much higher than that. Since 1900, that has declined to 7.2% and real equity returns have lagged the US' 6.5%/yr., but been alright at 5.3%. The other precedent is Japan in the early 1990s. Japan was the largest equity market in the world in 1990 at 41% compared to the US' 30% before its bubble collapsed. Its weighting in the world index has since fallen from 41% to 8% and according to the Yearbook, equity value was still just one-third of the early 90s peak at the end of 2014.

Further, looking through the yearbook expanded my horizons. Yes, there are other developed markets that have been around for hundreds of years that are very feasible to trade. That led me to begin comparing the US market to others, which leads me to my next point.

#2 - Japan is the world's second-largest market

Once you expand your horizons beyond the US, the question becomes: where the heck do you go? Well I know where I don't want to go: China and other countries where I can't trust the numbers. I don't mean this as cultural disrespect and I am sure there are many companies, China and elsewhere, with good governance and reliable financials, particularly among larger companies, but those generally aren't the ones I'm looking at and I've heard too much about rampant accounting fraud and other issues. With China it is not as huge a deal for me, but in much smaller markets I also worry about stuff like major currency devaluation. I'm not talking small devaluations - I mean double digit moves or where the currency becomes completely worthless. Tail risks like that increase substantially in the much smaller markets.

In all these respects, Japan is an attractive alternative. It is the second-largest equity market. Even the microcaps on its market with USD-equivalent market caps of $10-50mm still have clean audit reports from Big 4 accounting firms like Deloitte, PwC Kyoto, Ernst & Young, and KPMG. There's been currency devaluation in the yen over the last few years, but anecdotally, I've seen many value investors in forums discussing their performance with investments in Japan and many have still made good money in USD terms over the last few years on their Japan baskets, despite the devaluation.

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But more importantly, I think forex markets are some of the most efficient in the world given the huge amount of dollars traded and macroeconomic information out there. In the long run, purchasing power parity should also hold. When I extend the measurement period on the chart above, I see what I want to see: 30 years of general stability in the USD/JPY, and before that, the big move was favorable to US investors in Japan.

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The point I'm trying to make here is that, while I am now more comfortable investing outside the US, I'm not interested in going anywhere. I want to stick to developed markets with adequate governance (some readers may disagree with this characterization of Japan; I will address it later in the series). Japan fulfills those requirements.

#3 - Japan is cheap!

I started by looking top-down. What markets are trading at the lowest valuation ratios?

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Source: Aswath Damodaran s Earnings, Book Value, and Sales Multiple Averages by Country Dataset

I already suspected that Japan and South Korea would be among the cheapest markets. David Hurwitz of SC Fundamental did an excellent presentation on South Korea a few years ago at Value Investing Congress and I've heard many value investors have had success investing in net nets in Japan. The data seems to confirm this. Across the 5 valuation metrics, Japan and South Korea look to be among, if not the cheapest markets shown. The metrics I give the most weight to above are P/B and EV/EBITDA and there is a huge disparity between Japan and Korea versus the US on these metrics.

There's also the matter of feasibility, though. I use Interactive Brokers and am a very small manager. The implications are that I'm easily able to trade in Japan, but not Korea. I believe you need to have some sort of special trading ID to invest in Korea as well as a broker with a direct relationship with the Korean Exchange, which does not include Interactive Brokers. I read somewhere that you can work with eTrade Korea, but that would involve having multiple brokers, which is something I'd prefer to avoid. So my interest moved toward Japan.

Want more proof of Japan's cheapness? Take a look at this graph, showing P/B of the Japanese market over the years:

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Source: Are Japanese Businesses Worth More Dead Than Alive?

Or this one, showing half of the world's net nets in Japan:

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Source: Hurricane Capital

You'll probably notice that the US has a good chunk on that chart above, but realize that there are half the number of equities in Japan as there are in the US and I'd say the Japanese net nets are much higher quality. They're not Chinese reverse mergers and many are consistently profitable.

While the Nikkei is currently at roughly the same level it was 20 years ago, as is Japan's GDP, don't be fooled.

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Japanese stocks are way cheaper than they were. Corporate profits have increased greatly, and the increase is sustainable because after World War 2, Japanese companies were not run for profits - the profits passed through to non-shareholder stakeholders (employees, consumers) and much was reinvested.

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For example, many Japanese companies offered employees lifetime employment informally, increased wages at a high rate consistently, and kept more employees than necessary (unemployment is and has been anemic in Japan). Now, companies in Japan are becoming more efficient. The use of part-time and temporary labor has become widespread and companies are actually setting return on equity targets. Even with the huge growth in corporate profits in Japan over the last 20 years on flat GDP, corporate profits as a percentage of GDP are still just 3%, much lower than the 10% in the US - which, by the way, makes me feel even more uneasy about the US, based on the chart below:

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So the profit component of the P/E equation has gone up (corporate profits up) while the P side has stayed constant (Nikkei flat). That alone indicates that Japanese equities must have become cheaper, but that's not all. Cash balances at Japanese companies have tripled over the last 15 years and 1/3 of the Japanese equity base is in cash.

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And I think this may actually underestimate the strength of Japanese balance sheets. Many Japanese companies have what is effectively cash invested in the stocks of other Japanese companies that they supply to and buy from. Perhaps the numbers above don't include these investments. And further, even if they were included at market value, I'm not sure that would fully value them because the Japanese market is generally cheap. If Company A has 1B of yen invested in the stock of Company B whose stock trades for less than net cash (read: undervalued), then the true value of that 1B is more than 1B and including it at 1B does not tell the full story. I would never actually assume a security holding is worth more than market value unless I'd done deep analysis on the company whose stock is held, but it's worth knowing that there is this other layer of cheapness.

In an interview I did recently, I described a situation I've observed in the US where pension plans artificially appear underfunded because of super-low discount rates used to determine the present value of future obligations. This negatively distorts balance sheet strength, and the dynamic is even more extreme in Japan. While US companies are using 3-4% as their discount rate, Japanese companies are using .75-1% and will likely decrease even more because of the recent government rate decrease into negative territory. Surely this is not the long-term "normal."

I'm not sure how else to say it. Looking at the Japanese market top-down from many angles, it looks really, really cheap. And the 25% selloff in the Nikkei over the last few months has made it much cheaper:

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#4 - Japanese governance is better than you think, and improving

In my search for individual Japanese equities, I haven't been screening for dividend yield or share repurchases. It's one of the criteria on my checklist for Japan because it is a strong indication of good governance and shareholder orientation in a market where many investors question these things, but I've been looking for it later in my process because it's not the most important thing I'm looking for- that would be value. And yet, I've managed to find at least a dividend yield of 1-2% on every single Japanese equity I've looked to check it for. In some cases, I've found dividend yields exceeding 3.5% and a history of heavy share repurchases. Many, many companies have over 5-10% of their shares in the treasury.

It's also not uncommon to find significant insider ownership in Japanese companies. Many are family-controlled, and contrary to popular beliefs these seem to generally be more shareholder-friendly and have heavier capital return. The incentive aspect of the insider ownership is generally outweighing the risk of empire-building.

Japanese companies are very lean at the corporate level. A company with 500 employees will have 460-470 working in the operating business and only 30-40 in what the Japanese refer to as the "management division." Executive compensation is also very reasonable - certainly more so than the US.

One of the historic problems for small investors with Japan has been the large minimum lot sizes. Many Japanese stocks have had minimum lots of 1,000 shares, and often have share prices exceeding 1,000 yen, meaning the least stock you can buy is 1 million yen or almost $9,000. That's far too large for many small investors - both in the US and Japan. However, many companies are moving to reduce minimum lots to 100 shares and doing stock splits. I've already encountered this at several companies. I view this as a very shareholder-friendly move. It is democraticizing the Japanese market.

Back to capital return. Dividends and share repurchases have increased very quickly over the last few years. Dividend growth is around 15% and Japanese companies just had a record quarter for share repurchases.

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On the cash management front, I actually think Japanese companies are doing a better job than many think. I've read that Japanese companies are spending in excess of $100B acquiring foreign companies (obviously at higher valuations than valuations in Japan which makes no sense from a financial engineering point of view), but this has not been my experience with small Japanese firms. I am yet to find a small Japanese company that has "wasted" its cash and destroyed value through acquisitions, screwing up enterprise value-driven valuation approaches. This is in contrast to the US, where it's happened to me on more than one occasion. For example, central to my thesis a while back on RPX Corp (NASDAQ:RPXC) was the company's cash hoard of a few hundred million dollars. So what do they do? They spend $232mm of it on an acquisition of another company at a much higher valuation than their stock trades and what frankly seems a high valuation on an absolute basis - over 4x revenue and >12x EBITDA. The Japanese companies I've encountered aren't doing this and they're actually trying to earn a return. Many have over 50% of their cash in other cheap stocks and risk assets instead of deposits earning nothing.

I agree that governance is much better in the US, but that's true of most other countries compared to the US and my impression is that the gap between governance in the US and Japan is much smaller at the small to microcap level. Many small public companies in the US have all sorts of related-party transactions where the company is renting office space from the CEO at above-market rates. The CEO will make over $500k per year - in some cases more than 10% of EBIT. In Japan I've not seen this as much. There is much more consistency in governance in Japan across the spectrum of company sizes.

Overall, my impression is that governance in Japan is definitely adequate for my purposes and seems to be improving very visibly and dramatically, which is a trend I want to benefit from.

#5 - Language barrier can be language opportunity

One of the biggest reasons US investors avoid Japan is the seemingly insurmountable language barrier. Hardly any Japanese companies, particularly small Japanese companies where the best opportunities are, report in English. Everything is in Japanese. You can get the financials on Morningstar (see example), but that's about it. That's a problem for a lot of investors. It feels like a blind leap.

One of the things I've been giving a lot of thought to recently is causality. The story. It's the way humans think and understand things. We understand things as causes and effects. This has huge implications in investing. I believe it was Peter Lynch who went as far as to seek out 'stories.' He wanted a narrative about how something would happen that would drive his returns in a stock.

I don't disagree that sometimes stocks go up and down for causal reasons that we can and do identify, but I also think they sometimes don't. Very frequently they fluctuate randomly. They'll also go up and down for causal reasons - but not the reasons we identified in advance. The problem with a good story is that it shuts your brain down. Once you understand the story, it's hard to imagine alternative futures where something completely different happens. It inhibits your rationality. The other important implication is that our affinity for stories combined with their limitations means that you can be a really good storyteller able to construct a very detailed, beautiful qualitative narrative for why a stock will go up… and be wrong. It can sound great, but be terrible analysis and totally wrong. As I wrote in my last article:

Like most human beings, I tend to think in narratives. Once you learn the investing lingo like value trap, sum-of-the-parts, economies of scale, etc. and if you're reasonably intelligent as I sometimes think I am, you can make a decent argument for most any stock as a buy or sell. That frame/narrative/argument/whatever you want to call it doesn't mean it's actually a good or bad idea. It just means you're good at making yourself and others think it is. There's a big difference.

So what makes for a great story? Lots of details! A great investment story comes equipped with a 1GB spreadsheet, a Bloomberg terminal full of data, deep research into the personality and work habits of the leading executives, channel checks, and a high-level, big picture plot to wrap it all together and explain why other investors just don't understand.

With companies that report in English, all that information is there for the picking. But what happens when it's not? I have had the crazy idea that it makes me more rational. When I look at a US company, I focus in on quarterly and yearly moves in revenue, margins, etc. It makes a big difference to me if revenue is going to grow 5% rather than 10% next year. I also extrapolate more. Whoa - revenue growth decelerated from 10% to 8% this quarter. If that continues, revenue will be flat over the next few years. Better sell. I do this because there are reasons, written in English, for the moves.

But I've had crazy experiences analyzing these Japanese stocks. If operating profits doubled last quarter or halved, it's far less significant to me. I find myself looking at the full 10 years of financials as one big cycle, which is what it really is, and valuing the business and measuring performance changes relative to that, rather than a given year. I feel more flexible analyzing companies. I don't feel the yearning of confirmation bias, doubt-avoidance, and all my other psychological flaws to just invest! There's no reason to because all the various stocks are undifferentiated numbers in a spreadsheet. There's no CEO or business model to fall in love with. There are names of course, but the names don't mean anything to me. Maybe I am not describing it well, but what I'm trying to articulate is that the lack of English financial reports has huge implications for the way you analyze these Japanese stocks. The consensus is that this is a big negative, but I think it's actually really helpful.

As a thought experiment, imagine you are a foreign investor who cannot read English. It is 2000. You come across a company called Yahoo! (NASDAQ:YHOO). Silly Americans naming a company that… Its stock trades at $110 per share. Its enterprise value and market cap are both about $200B against just $1B of revenue, $200mm of EBIT, and a tangible book value of $1.5B. What the… This can't be right. Maybe the numbers are wrong or something. Either the numbers are fuzzy/wrong or this is ridiculously expensive - either way I'm moving onto the next one. Huge losses avoided.

So it can be a good thing that Japanese companies don't report in English, but don't think you can't get the information you need. The Japanese equivalent of SEC Edgar is EDINET. There you can search for the financial reports of Japanese companies. Download the XBRL versions and open the containing HTML files in Chrome. You'll then be able, through Google Chrome's built-in Google Translate function, to get a rough translation of all the reports. It's good enough to verify that the company has a clean audit, understand the financial statements, verify in footnotes that investment securities are actually stocks and bonds, get a basic sense of what the business does, and see if there is customer concentration and if the business is an exporter. If this sounds like a specific list, that's because it's a lot of the stuff I've been looking for. The Morningstar, Financial Times, and Reuters websites are excellent for getting an English business description, 10 year financials, recent developments, etc. Finally, a Japanese publishing company, Toyo Keizai, puts out an English Moody's Manual-type resource called the Japan Company Handbook with a half page of info for all the thousands of companies listed in Japan. It can be ordered here for $150. I have the Japan Company Handbook and have found it helpful. Interestingly, a few years ago a few bloggers noticed that Buffett was reading JCH from a picture of his desk. Buffett has also been interested in and invested in South Korea, per David Hurwitz presentation mentioned above. So, fear not, successful investors are seeing the same value you are and the information you need is out there.

#6 - Capital will rotate to Japanese stocks

This is ancillary to my thesis, but I've been reading news about Japan as well as books about Japanese culture. The Japanese are generally extremely conservative. The older generations in Japan put away about a quarter of their salary as savings and invest it in "low risk" assets - mainly government bonds. The collapse of the stock and real estate bubbles 25 years ago in Japan has made the Japanese avoid stocks and real estate and focus on government bonds. Further, with deflation and ever-decreasing interest rates, the Japanese have become accustomed to earning returns in excess of the coupon on their JGB investments.

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The government is pushing for inflation though and higher interest rates eventually are inevitable. Further, the recent rate move - making interest rates negative, probably has a big psychological impact on Japanese savers. This bond says I'm going to lose money? Why don't I just put the money under my mattress - or, better yet, in stocks! Finally, part of the government easing approach has been buying Japanese equities through ETFs. This all points to a capital rotation in Japan from fixed income to equities.

#7 - Individual Japanese Stocks are Insanely Cheap!

I think this is the single most compelling reason why Japan is interesting. It's what put me over the top and convinced me to put my yen where my mouth is. Here I will mention a few of the Japanese stocks I own, both to provide readers with ideas, and to illustrate how cheap real individual stocks are in Japan. Right now I own 17 Japanese stocks, of which I'll introduce 3 here. I expect to introduce others in future articles.

First, let's talk about investment criteria. Most US investors looking at Japan have taken an asset-based valuation approach, that is, they've focused mainly on stocks that look cheap relative to assets. Low price/tangible book and P/NCAV. I've tried to do things a little differently, both because I think it makes sense and because the stocks in Japan are cheap enough to allow me to. I've tried to look at Japanese stocks through two lenses: are they cheap on a going concern basis and are they cheap relative to asset values. I place more emphasis on the going concern valuation because I think, to some extent, an asset is only as valuable as the cash flows that can be derived from it, but I also take the asset values into consideration. In screening for stocks, I used a combination of low P/B, P/E, P/CF, and P/S. I also screened for companies with profitability over the last 12 months and positive average margins over the last 5 years. I'm looking for cheap stocks that trade for much less than intrinsic value, but also situations where cash is still coming in the door and intrinsic value is increasing. The other important part of the profitability aspect is that it makes me much more confident in what can otherwise be somewhat arbitrary assumptions. It's hard to know what multiples Japanese businesses should trade for, but if you can identify a business that trades for less than cash (negative enterprise value) despite consistent profitability, you know it's undervalued because a consistently profitable business is worth something and should trade for a positive EV. But what positive multiple to assign? A good rule of thumb I use is 10x EV to long-term "maintenance" FCF is a no-growth valuation where you could get 10% annual returns. Almost every Japanese business I've invested in has consistent, stable profitability, and in all cases I've assigned FCF multiples of less than 8x, so well below a no-growth valuation. The average is probably around 6-7x.

I've given at least a cursory look to hundreds of Japanese stocks so far and, again, these are a few of the 17 that I own right now.

Otec (Ticker: 1736)

  • A good HVAC installation and maintenance contractor with steady business.
  • 4.3B yen net cash on a market cap of 3.8B despite generating 1.3B of EBIT and 1.3B of FCF in the last year.
  • Over the last 9 years, they've generated 8.3B of EBIT and 5.9 B of FCF.
  • They've been profitable every year and generated free cash in all but one year.
  • Trades at 36% of TBV and 61% NCAV
  • Strange that their financials show no capex from 2013-2015, but I verified that the numbers are accurate.
  • Like many construction businesses, make sure to net cash down by the "billings in excess of cost" liability account as this isn't truly excess cash. In Otec's case, it is translated a little poorly and called "uncompleted construction accepted gold," but you'll know it when you see it and that is 1.34B as of 12/31/15.
  • The stock has sold off recently. Although the Japanese market has gone down, making Otec's decline fairly normal, they did just report their Q3 financials on Feb 10th. However, the financials look fine. Revenue was up 20% y/y and EBIT flat.
  • Expected 3-yr return from 714: 172%
  • Bear case return: 82%

Taiyo Kisokogyo (1758)

  • Civil engineering firm with two fairly equal revenue streams from public works and residential projects
  • Have not reported Q3 results yet
  • Has benefitted from seismic-strengthening investments in Japan post-Fukushima earthquake/tsunami in 2011
  • Around 3.5B yen net cash on a market cap of 2.3B
  • LTM EBIT of 563mm and negative FCF of (404)mm, however, the negative FCF is due to a big working capital swing, which is not unusual for an EPC firm
  • Over the last 8 years, they've generated cumulative EBIT of 3.8B and FCF of 2.3B. EBIT has been at least 250mm in every year and FCF has been positive in 5/8 years
  • 2.3% dividend yield and they've repurchased shares fairly heavily, with 1/8 of common shares in the treasury and sharecount reduction of about 10% over the last 5 years
  • 1,000 share minimum lot and 650 share price make minimum purchase size about $5.8k
  • Trades at 39% of tangible book and 56% of NCAV inc. LT investments which consists mostly of listed stock
  • Expected 3-yr return from 650: 190%
  • Bear case return: 126%

Daiichi Kensetsu (1799)

  • A construction firm specializing in railroad construction and maintenance
  • 60% of sales are to its parent company, East Japan Railway, which owns 7.5%. This sort of extreme customer concentration is not uncommon in Japanese small-caps. Because I am taking a basket approach (no single Japanese stock is more than 3.5% of my portfolio and most are around 2%), I am willing to accept idiosyncratic customer concentration that I wouldn't if I was doing very deep research and taking big positions.
  • The relationship with East Japan Railway and nature of the work provides stability to the business because half of that relationship's revenue (and probably close to half of total revenue) is railroad maintenance, not new track construction
  • Just reported Q3 results, which on the surface, seem good. Revenue was up around 10%, operating income up 13%, and cash balance increased by around 500mm
  • One of the most difficult things in analyzing this stock and Japanese stocks in general is verifying the investment securities. There is a lot of cross holding in Japan, equity method shares in affiliates investments, etc. that I'm not sure I really want to include in net cash. Generally, what I've been doing is vetting by looking for schedules of stocks and bonds that I can tie the balance sheet number back to. If not everything is accounted for, I haircut the securities balance by 50%. In the case of Daiichi Kensetsu, all of the securities are accounted for - they have stock, bonds, and other investments which include a bond fund, REIT fund, certificates of deposit, and money trusts. However, there are some obvious and significant cross holdings. I mentioned already that East Japan Railway owns 7.5% of Daiichi Kensetsu. Well DK 1799 also owns stock in EJR, and it was on the balance sheet at 2.3B at FYE 15. That alone is cause to haircut all of the investments by 50% to be conservative. I get net cash as of Dec 31, 2015, at 16.6B, compared to a market cap of 22B.
  • Clean audit Ernst & Young
  • Trades at 45% of TBV and 83% NCAV
  • EBIT of at least 3.3B in all of the last 9 years, 40B total. Very cash flow conversion (about 25%) but fairly consistent FCF 7/9 years and 10B cumulative total
  • One of the least attractive of the basket right now. Initially, I was not as conservative with my treatment of the cash balance. I am near my target allocation to Japan, but still actively looking at potential investments. It should be fairly easy to find something more attractive, so I will likely replace this with something else.
  • Expected 3-yr return from 1,072: 60%
  • Bear case return: 32%

This article is primarily a thesis that certain individual, small, value Japanese stocks will perform very well, but the Japanese market as a whole is cheap and if it is not feasible for you to invest in individual companies in Japan, there are some decent ETF alternatives, such as SPDR Russell/Nomura Small Cap Japan (NYSEARCA:JSC) and Hedged FTSE Japan ETF (NYSEARCA:HGJP). JSC is more targeted to the small stocks I'm interested in, while HGJP has lower fees. I am fairly indifferent to the hedging as I think the currency market is fairly efficient.

Conclusion

Even after the sell-off in the US market, I still think it's appropriate to be cautious with US stocks. But rather than sitting in cash, investing in a basket of small, carefully picked value stocks in Japan is an attractive alternative. To recap, the rationale for investing in Japan is:

  1. Questioning the US
  2. Japan is the world's second-largest market
  3. Japan is cheap!
  4. Japanese governance is better than you think and improving
  5. Language barrier can be language opportunity
  6. Capital will rotate to Japanese stocks
  7. Individual Japanese stocks are insanely cheap!

Investing is a lonely endeavor, even more so when you are in an unfamiliar territory like Japan. I am very grateful to the bloggers on CornerofBerkshireandFairfax and other sites as they provided invaluable information, much of which I've just reiterated here. I am happy to discuss investing in Japan and other topics in the comment section of this article, direct message, or email.

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Disclosure: I am/we are long RPXC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long 1736, 1758, 1799