Three reasons why I’m optimistic on Japanese equities

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Investors are overlooking a number of structural shifts that could help improve returns in Japan.

When Japan has hit the headlines this year, it’s largely been for short-term factors. A change of prime minster, the postponement of the Tokyo Olympics and a relatively successful handling of the Covid-19 crisis are all noteworthy. But there’s a longer-term story for equity investors that has been temporarily eclipsed by these events.

As far as the current pandemic goes, we think the second quarter will prove to have been the trough in terms of company earnings. Market expectations are for earnings to pick up from Q3 onwards, but this is already largely reflected in valuations.

Instead, we think there are longer-term structural reasons to be positive about Japanese equities. Specifically, we see numerous companies with the potential to improve their return on equity (RoE).

RoE is a profitability measure. It reveals how much profit a company earned in comparison to the shareholders’ capital retained in the business. A higher RoE typically translates into higher returns for investors. It is a very useful measure for comparing companies to their peers operating in the same industry.

Japanese companies have already made strides when it comes to improving their RoE. The chart below shows the spread of RoE for Japanese companies in 2013 (blue bars) and in 2019 (green bars).

As we can see, there has been a shift over time towards the right hand side of the chart, with more companies in those higher RoE buckets in 2019 than in 2013. But there’s still a long way to go for many companies.

We think there are several structural shifts that can help propel further RoE improvements: better corporate governance, a focus on shareholder returns, and improved productivity. Progress in these areas in Japan remains intact, despite the pandemic and the change in prime minister.

View Full Article – published by Schroders on 11th November 2020