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Corporate Japan - recognising shareholders

Japanese corporate culture is changing for the better. We look at how higher profit margins are helping Japanese firms invest for future growth that could benefit investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

When you buy a share in a company you own a small piece of that business. You own a portion of its assets and a portion of any profit it makes. If its profits increase, its share price could go up as well.

But something strange has happened in Japan. Company profits have risen for most of the past decade but its stock market’s failed to keep up. Is this an opportunity to buy Japanese shares at attractive valuations, or have they fallen back for good reason?

Laying the foundations for future growth

Future profits should have a bigger impact on share prices than what they’ve been in the past. Analysts predict they’ll be 0.5% lower in Japan this year. But we think this overlooks an important part of the story.

Japanese firms have been guilty of hoarding cash in the past, neither returning it to shareholders nor investing it for future growth. Prime Minister Shinzo Abe’s plans to reform the economy have focused on improving corporate governance – the way that companies are run by senior managers.

Company boards are focusing more on shareholders. And cash is being used to boost investor returns through dividend payments and share buyback schemes. Progress has also been made on important issues like boardroom diversity, though there's still more to do.

The profit margins of Japanese companies have hit record highs in recent years. This gives companies more money to invest for future growth, and that’s what they’re doing. Spending money on, say, more employees or more advertising reduces profits today but gives companies a stronger platform to grow from in the future. Profits are expected to grow 6.3% in 2020 and 5.1% in 2021, although nothing is guaranteed.

We think these changes in corporate culture could make Japan an attractive long-term investment, even if profits fall in the short term. Japanese managers are realising that cash needs to be invested for future growth, or returned to shareholders.

There are other factors that make Japan an attractive place to invest. Interest rates have been kept low, so Japanese consumers aren’t having to tighten their belts yet. And it’s also cheaper for companies to borrow money to invest for future growth.

A changing nation

Japan does face some challenges. Its population is aging, so there’s less people to spend money on goods and services and, without immigration, a smaller workforce. This means its economy is not expected to grow as quickly as some other developed nations.

Government debt is also high. Any serious concerns about Japan’s ability to pay these debts could push up interest rates. This is usually bad for business as companies and consumers would have to pay more to borrow money.

Opportunity

We can look at how expensive the Japanese stock market is compared to others by dividing its price by its companies’ profits. This is known as the price earnings ratio. It shows how much you are paying for each unit of profit earned. If a company makes £10 profit in a year and you have to pay £100 for the company, the company costs ten times one years’ profit – its price earnings ratio is 10. A lower number implies a cheaper market.

Stock market price relative to company profits

Past performance isn't a guide to the future. Source: Bloomberg to 29/01/19

Sometimes it pays to be cautious and sometimes the caution of others presents great investment opportunities. We think the Japanese stock market looks cheap compared to others. But there’s no rule to say it can’t go down further as stock markets both rise and fall, so you could get back less than you invest.

Japanese companies are investing for growth and if you take a long-term view, rising profits are usually accompanied by rising share prices. We think it could be worth including Japan in a well-diversified investment portfolio. Our favourite managers for investing in the region can be found on our Wealth 50 list of funds.

See the full list

This article isn’t personal advice. If you’re not sure an investment is right for you, please seek advice.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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