There is a lot of attention on the Japanese market right now, with many industry voices suggesting that Japanese equities present one of the most exciting opportunities for investors in the last 20 years.
Media reports have highlighted a number of high-profile value-orientated investors who have been increasing their investment in Japanese stocks. Last month, Japan’s stock market reached its highest level in 33 years, with record inflows from foreign investors. In fact, the Nikkei 225 and the Topix indices were up 19% and 14% between the start of 2023 and 24 May respectively in local currency.
Instrumental to this has been a spike in efforts amongst Japanese companies to improve their corporate governance – something which foreign investors have considered to be a key risk in years gone by. Companies are now demonstrably adopting higher standards and doing more to improve dividends and buybacks.
There are clear reasons for this, from the implementation of a stewardship code in 2014 to, more recently, moves by the Tokyo Stock Exchange requesting companies to draw-up a plan denoting what they would do to improve governance. Pension funds are also now disclosing how they vote, and we are seeing more interest from activist investors in Japan.
Looking at the domestic economy, we are also starting to see encouraging signs of inflation and wage hikes which could boost the economy, particularly consumption. The latter is particularly significant and exciting in an economy like Japan, where we haven’t seen wage hikes for roughly 30 years.
Finally, this is all backed by compelling stock valuations in the region, with 50% of Japanese companies currently trading on a price-to-book of less than one. Investors are also often surprised to learn that Japan remains behind most other advanced economies in many key growth themes, such as e-commerce and digitalisation, yet well placed to benefit from other wider themes such as deglobalisation. Such growth-oriented companies are set to gather momentum over time and provide resilient, long-term sources of returns for investors.
Driving growth through Japanese e-commerce
A prime example of where Japan offers a compelling growth opportunity is e-commerce, where the penetration of e-commerce within the Japanese retail market is just over 10% and remains much lower than in China, the UK, South Korea or the US. Similarly, the percentage of cashless transactions is very low compared to the UK. As such, for the long-term, we continue like GMO Payment Gateway, which is a leading provider of processing services for online commerce and credit card transactions. With the onset of the pandemic accelerating many digital trends such as cashless payments, we believe GMO Payment Gateway is well positioned to tap into the growing opportunities in the sector.
Tapping into the digitalisation of Japanese businesses
Standardised cloud-based software for businesses is another digital theme presenting an exciting growth opportunity for investors in Japan. Historically, many Japanese companies have used internal software solutions, but now that the first generation of software engineers is reaching retirement age, there is an imperative for businesses to switch to standardised software solutions. Japan’s demographics situation will add impetus to this as a structural shift over time and companies such as OBIC, a supplier of business administrative systems, provide the portfolio with exposure to this.
Supporting deglobalisation through automation
With wage inflation now an issue in the US and other markets, businesses establishing new production plants and warehouses have a stronger incentive to incorporate factory automation into these facilities wherever feasible. Japan is fortunate to be home to some of the world’s leading automation companies, such as Keyence. The company is backed by a strong consulting sales approach and has seen market share grow from 30% to over 50%. It also performs well considering the structural growth of factory automation under rising labour costs. The company has operating margins north of 50%, consistent positive free cash flow generation and a strong balance sheet.
Whilst Japan currently presents an exciting opportunity, stock selection is key given supporting factors are coming from several different directions. For example, the economic recovery is likely to benefit companies focusing on domestic or tourist demand, while regulation change boosting shareholder value are more likely to benefit value stocks. Simultaneously, companies with strong technical and innovation intellectual capital that have strong long-term earnings potential are also in a strong position to benefit in today’s market.
For investors, taking an active approach is vital to navigating this potentially lucrative market. Japan is subject to relatively little analyst coverage, meaning that an on-the-ground presence is needed to best understand what makes these companies tick and help investors capture the best opportunities in this thriving landscape.
Miyako Urabe and Nicholas Weindling are managers of the JPMorgan Japanese Investment Trust. The views expressed above should not be taken as investment advice.