Perspective

Why value investors are shopping in unfashionable Japan


One thing you can always guarantee in markets, as in fashion, politics and tastes, is that everything changes. Back in the early 2010s, for example, Germany went from being the “sick man of Europe” to an economic powerhouse. We believe something similar could now happen with Japan.

For some, this will come as a surprise. After all, over the last decade and more, Japanese companies have actually been ridiculed on account of their balance sheets. To be clear, this was not because they were weak but because they were seen as “unnecessarily” strong.

Essentially, a strong balance sheet means a company has a lot of cash or other assets, enough to cover its liabilities. This might just sound sensible to some. Certainly it does to us on Schroders’ value investment team.

On the Schroders value team our investment approach revolves around identifying businesses that trade at a significant discount to their “true” value. We uncover the true value of companies based on their “fundamentals”, such as their profit-generating potential or balance sheet strength.

We want our companies to be sufficiently robust financially in order to survive periods of market turbulence – and so give the wider market the best possible chance to recognise their worth.

However, over the last decade the market has tended to reward companies that have taken on cheap debt at a time when interest rates have been incredibly low. Conservative companies with piles of cash have been out of fashion.

With markets and businesses now hit by the Covid-19 pandemic, concerns about overly strong balance sheets look especially odd. Now that times have changed again, some people may need to reconsider how they view a company’s financial strength.

Certainly, one can imagine the many highly-indebted business in the US and Europe looking enviously at their Japanese counterparts, whose record levels of cash reserves may now give them a great advantage.

Indeed, according to the Financial Times, Japanese-listed companies had more than $6 trillion of cash and short-term securities on their balances sheets at the end of 2019. To put this figure in perspective, it amounts to more than 130% of Japan’s GDP.

This is more than three times the equivalent ratio in the US. Around one-third of that cash is concentrated among the tech giants, rather than spread across various sectors as in Japan.

Despite the adverse environment they now face, then, Japanese businesses will still be in a position to invest in both capital expenditure and research and development. They will still be able to remunerate staff and pay dividends for far longer than companies anywhere else in the world.  Another consequence of this discrepancy could be a surge in merger and acquisition activity, both in Japan and abroad.

Although change is a constant in markets, one thing that doesn’t change for us is a focus on companies’ balance sheet strength. This means that when we’re looking globally for value opportunities, we have been increasingly drawn to Japanese companies over the last year or so.

We’re seeing the remarkably high calibre of Japanese companies’ balance sheets being matched by the remarkably low nature of their valuations. We think these are winners that are currently priced as losers. Until everything changes that is...

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.