FLJP - Why Buffett Is Betting On Japan
2023-04-22 10:58:00 ET
Summary
- There’s a growing list of reasons to consider Japanese small caps, including strong balance sheets, improving capital efficiency and attractive valuations.
- During a visit in April, Warren Buffett disclosed that Japan had become Berkshire Hathaway’s second-largest country allocation after the U.S. We tend to share Buffett’s enthusiasm.
- Inflation is simmering, but our channel checks indicate local firms are passing on costs to protect margins.
By Kei Okamura
There’s a growing list of reasons to consider Japanese small caps, including strong balance sheets, improving capital efficiency and attractive valuations.
During a visit in April, Warren Buffett disclosed that Japan had become Berkshire Hathaway’s second-largest country allocation after the U.S. We tend to share Buffett’s enthusiasm - especially for Japanese small caps with good growth prospects, strong balance sheets, improving capital efficiency and relatively attractive valuations.
On the growth front, Japan’s economy appears poised to grow 1.3% in 2023 - slightly shy of the U.S. but outpacing Europe 1 - as exports to Asia rebound while domestic spending remains resilient. Inflation is simmering, but our channel checks indicate local firms are passing on costs to protect margins.
Amid higher interest rates, we believe companies with strong balance sheets will be rewarded for their ability to self-fund their growth. As of December 2022, the median Japanese small cap was net-cash (with a -6.8% debt-to-equity ratio), versus its net-debt U.S. and European peers (17.1% and 32.5%, respectively). 2
While excess cash can crimp returns on equity - a big reason, in our view, that Japanese equities have traded at discounts versus international peers 3 - increasingly vocal investors and governance reforms have ignited the highest volume of share repurchases in 16 years. 4 Small caps are following suit after the Tokyo Stock Exchange announced new guidelines to over 3,000 listed companies calling for higher capital returns. In the past, such regulator guidelines have been considered “soft laws,” and we believe the best small caps will take meaningful action - not just share buybacks - to improve ROE, potentially creating an attractive market for active investors.
The last time Buffett visited Japan was in 2011, shortly before the late Prime Minister Shinzo Abe helped spur the country’s multi-year bull market. We’ll see if history repeats itself.
Source: (1) 2023 Economic growth forecast as expressed in year-on-year percent change, Japan: 1.3%, U.S.: 1.6%, Euro Area: 1.0%, World Economic Outlook, International Monetary Fund, April 2023; (2) Jefferies, December 2022; (3) Price-to-book ratio, MSCI Japan small cap: 1.0x, MSCI U.S. small cap: 2.2x, MSCI Europe small cap: 1.5x, Bloomberg, April 2023; (4) Nikkei Asian Review, March 2023.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investment decisions and the appropriateness of this material should be made based on an investor's individual objectives and circumstances and in consultation with his or her advisors. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. The firm, its employees and advisory accounts may hold positions of any companies discussed. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory accounts may hold positions of any companies discussed. Specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable.
Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and jurisdictional limitations and restrictions.
The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.
© 2009-2023 Neuberger Berman Group LLC. All rights reserved.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
Why Buffett Is Betting On Japan