Follow Warren Buffett to Japan
Warren Buffett’s Berkshire Hathaway recently bought a 5% stake in five Japanese general trading companies, known as “sogo shosha”.
Jesper Koll, Japanese WisdomTree strategist, believes that a number of considerations beyond traditional low-cost valuations and high cash flow motivated Buffett’s purchases:
- Sogo shosha can be a great hedge against inflation. They are an integral part of global commodity markets, both soft and hard. Stocks generally follow inflation, which is important as many investors are now looking for good inflation hedges.
- Sogo shosha are dominant venture capital firms in Japan. They see every case. Buffett buys one of the best filters for Japan and innovative Asian start-ups.
- There is a geostrategic advantage. As the technological cold war between the United States and China escalates, Japan is poised to become a big winner. Sogo shosha will be one of the main negotiators, as global companies are forced to switch from Chinese suppliers to Japanese suppliers.
- The Sogo Shosha are at the forefront of Japan’s transition from seniority-based pay to performance-based pay.
All in all, buying Buffett is a reminder that there are good values ââto be had outside the United States.
Below, I review some of the broader portfolio applications of Buffett’s âBuy Japanâ strategy, and why investors may want to follow his lead.
WisdomTree has a basket of dividend-weighted Japanese companies called the WisdomTree Japan Hedged Equity Fund (DXJ). DXJ currently gives more weight to these soga shosha than the Japanese market capitalization weighted indices, thanks to their current high dividend levels.
DXJ owns four of the five companies bought by Buffett for 6% of its portfolio, compared to only 3.5% for the five companies in the MSCI Japan index.
These sogo shosha have prices averaging 79% of their book value, with four of the five being less than 85% of book value. If you believe in the quality of that book value, you are buying an asset for less than the liquidation value that provides good current cash flow through dividends and redemptions.
These five new holdings from Buffett are also currently trading at 4 times cash flow, for an average cash yield of 25%.
As of August 31, DXJ had a price / cash flow multiple of 7.8 times, or approximately 13% cash flow yield, not far from the Buffett basket.
The US market and the S&P 500 index, on the other hand, have a price-to-cash flow ratio of over 16 times, with a cash flow return of just 6%, which is 75% below the cash flow levels of treasury of Japanese companies in Buffett’s Japanese portfolio. .
The DXJ’s current dividend yield, although lower than that of Buffett’s Japanese portfolio, is now approaching double the level of the S&P 500, at over 3%. Japan hasn’t been known as a high dividend country for decades. But the renewed focus on returning liquidity to shareholders and improving returns on equity has made Japan a leader in dividend growth. While S&P 500 dividends have grown 10% per year over the past decade and prices have appreciated with this growth in dividends, Japanese dividends have grown 8.5% per year over the past decade. decade and prices have generally increased less (around 7%).
Comparison of ratings
For definitions of terms in the table, please see our glossary.
Stepping back, Japanese equity valuations have contracted over the past three decades. After the Nikkei peaked to nearly 40,000 at the end of 1989, to just over 23,000 more than 30 years later, valuations have continued to compress.
In the early 1990s, Japan was trading at over 60 times profit1, while the S&P 500 was less than 20 times earnings. Now the US market is trending with expanding multiples, while Japanese valuations languish.
Japan was trading at multiples similar to the S&P 500 after the Great Recession of 2009 from 2011 to 2015. But from five years ago, the S&P 500 decoupled, led by the big tech stocks which fueled a rise in the S&P 500 earnings multiple.
As of August 31, the S&P 500 had a P / E ratio of 26 times, while that of MSCI Japan was 18 times and that of DXJ was 16 times.
Price / earnings ratios
Japan is clearly expected to trade at a lower multiple given the different industry compositions and growth profiles. But its exposure is aligned with a reopening of the global economy given the cyclical nature of Japanese companies. The nation is heavily dependent on global growth, with an emphasis on industrial and consumer cyclical societies. Global fiscal stimulus is expected to support it in the wake of the coronavirus pandemic.
While US markets are generally “priced for perfection,” Japan is trading at its lowest multiples in decades with the potential for positive catalysts: renewed global growth, an under-owned market and now the investor of. ultimate value that could restore confidence in Japanese assets.
Buffett engaged in a very interesting yen-denominated bond issue last year, raising 430 billion yen of yen-denominated bonds (over $ 4 billion). If the yen loses value, its debt will decrease in US dollar terms, offsetting the losses resulting from being inherently long in the yen when buying these stocks. This allows Buffett to isolate the true âequity opportunityâ without having to navigate a separate currency bet.
We believe that investors should also consider taking this type of approach. DXJ incorporates this currency hedging to neutralize movements in the yen and help investors focus on potential gains from Japanese stocks.
Unless otherwise indicated, data sources are WisdomTree and FactSet, as of August 31, 2020.
1. Based on the MSCI Japan index
Significant risks associated with this article
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