With the Topix index of Japanese shares having seen a 21% increase since the start of this year, there is a question whether these shares still look attractive from both a fundamental valuation and a supply and demand basis.
Yoshitaka Sakai, equity chief investment officer at Asset Management One, thinks Japanese shares still have mileage in them – and investors should take note.
Sakai said that earnings per share have been rising at an average of 8% per annum over the last 10 years, yet, despite that track record of growth for Japanese companies they are still trading at a substantial discount to other markets.
Japan is the only major stock market to trade at price to book ratio of less than 2.
The Nasdaq trades at a price to book ratio of 8 and the S&P500 at around 5.5, whereas Japan’s Topix at just 1.6x.
Corporate reforms, that have been led by the Tokyo Stock Exchange’s drive to improve corporate governance and shareholder returns, could also lead to a higher return on equity (ROE).
That is partly because share buybacks are reducing equity and because Japanese companies are being more rigorous over the projects that they invest in.
Sakai said that he expects that Japanese shares should reach an ROE of 10 in the next few years.
“That improvement in ROE should lead to more investor interest and push price-to-book from 1.6 to 2x,” said Sakai.
And according to Sakai, corporates undertaking share buybacks are now amongst the biggest purchasers of Japanese equities.
Share buybacks now represent approximately 1.7% of the Japan’s market capitalisation.
Last year’s record share buybacks of ¥14trn are expected to be beaten with a total of ¥18trn in buybacks in 2025.
Takeover bids and MBOs are also another major category of purchasers of Japanese shares and represented over two billion yen in purchases of listed shares last year.
Meanwhile, Sakai expects that one of the biggest sellers of shares – that of Japanese corporates selling their shareholdings in other corporates – are expected to have reached a peak in their activity within a year and then to fade.
In 2025 the sale of cross-shareholdings is expected to be around ¥10trn.
Cross shareholdings now represent less than 6% of the total market value of the Tokyo Stock Exchange down from 14% of market value in 2005.
“We see that primary selling force is declining as cross-shareholdings have faded away,” said Sakai.
Corporates have been selling down cross shareholdings as part of Japan’s corporate governance reforms.
The previously high level of cross shareholdings in Japanese companies had been seen as a way of blunting the pressure from shareholders to improve returns and as a way of blocking takeover bids.
Reducing cross shareholdings makes takeovers easier to execute and should improve shareholder returns.
As well as encouraging greater capital efficiency and shareholder buybacks corporate reforms in Japan will see the number of companies in the Topix reduced from 1,700 this year to 1,200 next year.
This is likely to lead to a sharp increase in more shareholder activity by Japanese companies who wish to remain in the Topix.
“Japan is able to produce companies that are global leaders. The economy is now solidly back on track and Japanese businesses are increasingly confident about earnings growth,” said Sakai.
Read more on Japan in the November issue here.
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