Posted by: donmihaihai | May 31, 2008

The word is Japan.

There is a possibility that Japan equities are the cheapest around, currently. I do not know for sure but that is the signal I am getting, not from local press print but from all kind of commentaries by some of the value fund managers who invest globally.

Nikkei has spent 18 years in the mud after the bubble busted where Nikkei stood at near 40,000. Last Friday it was 14338.54 which is a gain of 22% from the recent low of 11691 reached in March 2008. But that is still a drop of 21% from one year high of 18297. In fact Nikkei dropped 36% when it reached the lowest point in March 2008. A drop of 36% or 21% does not mean Japan equities are cheap but consider after spending 18 years in the mud and Japan Equities did not raise as much comparing to other countries after Equities hit a bottom in 2003, it is the last place to be associate with bubble.

The place to be may be in small and medium cap. Latest APS investment theme for 1Q2008 at their website, available free, showed that small and medium cap was near to the lowest valuation in term of P/E and P/B during March 2008. The other two times it happened was during Dec 2002 and Oct 1998 which were also around the bottom of Japan Equities at those periods. If March 2008 was another major bottom, then Japan equities had hit bottom 3 times in 10 years. Investors foreign or Japanese are ignoring Japan for that to happen and as a contrarian, this is one of the bullish sign. Since Japanese companies ROE is very low, it is quite pointless to look at P/E but P/B is different. Using the data from APS, it shows the highest P/B was 1.34 while the lowest was 0.81. On an index or average basic, 1.34 is cheap, 0.81 is even better.

One by one, successful fund managers in US who invest globally talk about Japan equities in their 1Q2008 shareholders report commentaries. Below are some of the comments from Mason Hawkins of Longleaf, Tweety, Browne funds and Jean-Marie Eveillard of First Eagle fund.

Mason Hawkins

While we have had our share of frustrations with Japanese management partners, we have observed slow but steady progress both in general and within the Fund’s holdings over the past decade. We prefer today’s Japanese opportunity set to those offered the last two times Japan dropped off investor’s maps in 1998 and 2003. Today’s valuations are similar, but returns on capital are higher, attitudes towards M&A have improved, dividend payouts are increasing, and share repurchases are accelerating. This activity extends to the portfolio, where Millea, Daiwa, and NipponKoa have all been significant repurchasers. Opportunities exist for improvement, but the fund’s Japanese companies enter this downturn with stable businesses and strong sheets in a capital-starved world. Most important, valuations discount Armageddon. For confirmation that valuations matter, we need only look across the Sea of Japan to China, last year’s sure-fire winner. Amidst all the doom and gloom about Japan, the Shanghai composite dropped an eye-popping 33% in the quarter compared to the 6.4% decline for the TOPIX. At last summer’s peak, the Shanghai Index traded at over 50x earnings. today, the Nikkei trades at about 13x earnings.

Tweety, Browne funds

Another area of current opportunity is in Japan. This is a country in which we have invested very little money in recent years, but one that is today, we believe, offering unusual value. The Nikkei Index is down over 31% from July 2007 through March 31, 2008 and is now trading at roughly 34% of its high of nearly 20 years ago.

Despite these obstacles, we believe that real opportunity is presenting itself in Japan today. The price/earnings ratio of the Japanese stock market is currently the lowest it has been in 30 years. The price-to-book value ratio for the broad Japanese market, at roughly 1.5 times book, is well below the price-to book value ratios of the U.S. and European stock markets. According to research conducted by our friend, Howard Marks, a respected value investor, the dividend yield on Japanese stocks, while low compared to Western companies, is now at or above Japanese government bond yields, which has happened only three times in the last ten years, and each time it has happened, the market has rallied.

Jean-Marie Eveillard

Today, the Ben Graham-type companies, in other words, the deep value stocks, are not available, really, in the U.S. or in Europe. They’re only available in Japan. And then, the great majority of those deep value stocks are small stocks. In view of the size of our funds today, as you know, we are looking more so into buying medium caps or large caps. At the same time, we have been doing some work and we already own a few, have owned sometimes for years, a few small deep value stocks in Japan and we’re in the process of doing some additional work on more.

I mean there are stocks in Japan where net cash, cash and sometimes portfolio securities, net of all financial liabilities, net cash is in excess of market cap, which means that you pay less than nothing for the business. Now, as Marty Whitman likes to say, “There is always something that can go wrong.” In that case, if the company were to suffer a string of losses for the next five years, then of course five years from now the cash would have disappeared as a result of the losses.

It is excited to know these superinvestors are looking at the same place. While I don’t think there is any successful Japan Unit Trust available to me locally but raising tide raise all ships. And yes, I have been a net buyer of Japan UT since 4Q2007.

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