2008: Time to Head Back to Tokyo

Andrew Morse in the Wall Street Journal Monday reported that 2008 could be the time for savvy investors to snap up some undervalued Japanese companies, particularly as 2007 had proven to be the worst year for Japanese stocks since 2002.

The Nikkei Stock Average of 225 companies fell 11% in 2007 to 15307.78, its first losing year in the last five. (The last trading day was Friday.) The Topix index, which is usually used by strategists because of its breadth, did worse, dropping 12% to 1475.68, also its first loss since 2002. Both indexes fared far worse than other Asian markets, which generally posted double-digit percentage gains.

The poor performance last year was attributed partly to the surge in the yen, and partly to Japan's apparent reluctance to embrace the "more aggressive shareholder capitalism", as seen in the U.S. and United Kingdom.

Analysts, Morse reported, viewed Japan as a golden opportunity to snap up undervalued companies, including even such blue chips as car maker Honda Motor (HMC) and copy-and-camera maker Canon (CAJ).

"Everybody is underweight Japan," said Shoji Hirakawa, a strategist at the Tokyo office of UBS... Mr. Hirakawa said foreign investors likely will prowl Japan for bargains in 2008. [He] forecasts the Topix index will rise to 1900 by the middle of 2008, which suggests a 29% leap.

Morse noted that Japanese shares were cheap in terms of price/earnings ratio - currently the Topix trades at a p/e ratio of about 16 (compared to a global average of 16.7) - and price/book value ratio - currently a little over 1.5 (compared with a global average of about 2.4). Mr. Hirakawa reckoned some 40% of the Topix companies had a price/book value ratio of less than one.

But Morse added a word of caution before investors race back into Japan: there are concerns that the yen has yet to stabilize against the dollar (the Fed's actions could affect this), and the Japanese economy was still far from its former heady days, as indicated by a recent Bank of Japan survey which showed business sentiment at a two-year low.

Worst of all, critics complain Japanese management teams don't run companies for their shareholders, but rather for employees and business associates. Shareholders who have tried to persuade companies to take their interests into account have been brushed aside, and more companies have adopted poison pills -- a plan designed to make a threatened takeover more expensive through the issuance of huge amounts of stock. Over the summer, Japan's Supreme Court ruled that a small condiment maker, Bull-Dog Sauce, could use such a plan to ward off a hedge fund that wanted to buy it.

However there are signs of change on this score. Some companies - Canon, steelmaker JFE Holdings (JFEEF) and trading house Mitsubishi (MTU) - are buying back shares, and dividends are rising. Dividend payments by the 1,742 companies on the Tokyo Stock Exchange's first section jumped 25% in the first half to 2.4 trillion yen, and UBS' Mr. Hirakawa expects this to more than double for the full year.