Japan’s known for its lost decade. Investors point to its crashing stock market in the late 1980s and early 1990s and how investors haven’t generated a real return from investing in the market for two decades.
Japanese stocks are notorious for poor performance. Why? It isn’t all economics.
Jim Grant Goes to Japan
Here’s an interesting anecdote from one of my all time favorite investors, Jim Grant. He tells this story of buying a company at an EV/EBITDA ratio of 1. The company’s market cap is pretty much cash. It has no debt. The business is solid as there aren’t any real competitive threats and it’s making a profit, which it has done year after year.
He goes to meet with management, and explains to his translator that he wants to ask why the company won’t take itself private with the cash or at least start buying back shares. Grant then suggests that it could later relist as a public company at a higher valuation.
American logic goes to Japan.
His translator says no. No. No. No. You can’t ask that in Japan for cultural reasons. You just don’t do that in Japan. Grant says there’s nothing to lose, so he demands his translator asks.
Apparently this question doesn’t go over well at all. His translator spends 15-30 minutes on a simple question. Ultimately, they respond that they can’t do it. It wouldn’t be good for employees, customers, suppliers, whatever. At no point do they mention the interests of shareholders, people who actually own the business.
Anyway, years later, the founder dies. The surviving son takes it private at a valuation 40-50% above the closing price on the last day of trading. That move takes it to…wait for it, less than book value.
Yeah, yeah, so you can find cheap and goofy backwards stocks on the American markets if you look small enough. But I’m not just talking about the small cap parts of the Japanese stock markets. Even huge companies like Nintendo (NTDOY) have ridiculous amounts of cash. Nintendo owns all kinds of gaming and electronic businesses plus the Seattle Mariners, and a treasury large enough to fund a small country.
You can buy Nintendo ADRs for $12.75 right now. For each ADR priced at $12.75, Nintendo has $11 in cash. So, net of cash, the market says the Seattle Mariners and Nintendo’s vast entertainment businesses and intellectual property are worth $1.75 billion. In the US, Nintendo would be crucified for carrying that much cash and it would have to enact a dividend or share repurchase authorization, or both. It’d be a target for investors. Conference calls would begin and end with questions about dividends and repurchases.
This is Japan, though. The cash Nintendo has isn’t ever coming back to shareholders…ever. It’s just going to sit there doing nothing. Nintendo stock is 90% bank account, 5% baseball team, and 5% electronics business.
Culture vs. Capitalism
Japanese businesses make a lot of money…and then they sit on it. So, where in year 1 you might own a company with $0 in cash and $1 in earnings per share, in year 40 you might own a company with $60 in cash and $2 in earnings per share. Your shares go from 100% equity to 90% bank account, 10% equity. The cash never leaves without a significant and unpredictable event, either. Nintendo will go bankrupt before its cash horde ever makes it back to investors. It’s too big, too well known, and too corporate to be impacted by any personal developments in the lives of managers.
If you tried to run a company like that in the United States you would get thrown out so quickly it wouldn’t be funny. Every activist in the world would launch an assault. Your board members would be burned at the stake. Barron’s, the Wall Street Journal, and CNBC would lambast you as terrible stewards of shareholder capital. Hedge funds would give presentations about how much you suck.
In Japan, culture dictates they do the opposite. Japanese business leaders sit on cash, rarely, if ever, doing what is necessary to get stock market-like returns.
Long story short, Japan’s lost decade is just the beginning of explaining the poor returns from Japanese stocks.