Pricey Japan Stocks Are Bargain in Top Fund’s Unorthodox Take

Despite Japan’s share market rally to a three-decade high in August, many big-name stocks remain cheap based on unconventional analysis used by a Deutsche Bank AG unit.

(Bloomberg) — Despite Japan’s share market rally to a three-decade high in August, many big-name stocks remain cheap based on unconventional analysis used by a Deutsche Bank AG unit.

Nintendo Co. and Tokyo Electron Ltd. are among stocks that a lot of market players would consider pricey but DWS judges are inexpensive. The Frankfurt-based firm seeks to find value by comparing companies across countries, regions and industries. It has a team of about 50 analysts that reconstruct corporate accounting data to make a firm’s figures directly comparable with others.

DWS evaluates companies’ fundamentals in a different way than the market’s norm. The analysts look not only at financial debt but also operational liabilities such as warranties, pension obligations and leases. Its figures are adjusted for inflation, and the analysis includes intangible investments such as research and development spending and advertising of brands. Their goal is to come up with the real value of companies, using a system they call Cash Return on Capital Invested, or CROCI.

The analysis method may be unusual, but its performance is respectable: DWS’s CROCI Japan fund is one of the top performers this year among peers that focus on the Asian nation’s shares, while returns on its CROCI Intellectual Capital ESG fund in 2023 have surpassed 93% of its rivals, Bloomberg-compiled data show. 

The funds are favoring Japanese shares at a time when the Tokyo Stock Exchange and activist investors are putting pressure on companies to take steps to raise their shareholder value. The nation’s corporate sector held 338 trillion yen ($2.3 trillion) in cash at the end of March, according to Bank of Japan data, money that companies could use for investment to boost returns.   


“One feature of Japan is that you get quite a lot of companies that hold a lot of cash and that don’t seem to be doing much with that,” said Dirk Schlueter, head of CROCI Investment Strategies at DWS based in Frankfurt. “Arguably that’s maybe one of the contributors to the rally already that we’ve seen this year, that maybe there is more hope actually of that cash being employed.”  

DWS isn’t alone in its bullishness toward the Japanese share market, as the central bank keeps its easy monetary policy even as inflation accelerates, while companies move to improve their governance. The Nikkei 225 Stock Average was seen rising to 34,500 by the end of the year, according to the median forecast in a Bloomberg survey of strategists and investors in August. The Nikkei was at 32,619 on Thursday.

“Our value strategies end up looking quite different compared to many traditional value strategies, because of the more comprehensive view we take of companies and their business models,” said Colin McKenzie, a strategist and CROCI product specialist at DWS in London. “We therefore often end up with a higher exposure to sectors that aren’t classically considered to be value sectors.”

Nintendo’s Cheap

In Japan, their analysis indicates that game maker Nintendo, for one, is cheap, considering its big cash holdings and strong earnings. That’s not a conclusion conventional analysts are likely to reach looking at the company’s price-to-book ratio of 3.09 times compared with an average 1.33 times for Topix-listed companies. Tokyo Electron and Chugai Pharmaceutical Co. are also among DWS’s picks, though their PB ratios far exceed the market average as well.

The Deutsche Bank group came up with the CROCI model around 1996, when European equity markets were growing just a few years before the arrival of the euro in 1999. The adoption of the unified currency highlighted the need to compare the value of companies spanning a whole range of countries and industries in Europe. DWS unveiled its first investment strategy in 2004 and introduced European, US and Japan funds.

DWS is a mutual fund arm of Deutsche Asset Management, which oversees 859 billion euros ($935 billion) in assets. It covers around 900 companies globally that are large cap and highly liquid. The firm aims to come up with what the total enterprise value of the firm might be if it were to buy the company entirely or take it over. 

Its Luxembourg-incorporated CROCI Japan fund, which manages 27.2 billion yen, has beaten 98% of its peers this year and focuses solely on value investments. 

The firm’s CROCI Intellectual Capital ESG fund, meantime, managed 33.3 million euros as of July 31 and puts its money in companies that have high cash flow and low debt such as Nintendo, Sony Group Corp., and Chugai Pharmaceutical.

Out of about 900 companies globally that DWS follows, the fund filters out firms that don’t have any R&D or brands, limiting the total to around 400. Of those, about 16% are Japanese companies. 

It’s overweight in IT and drug companies that spend a lot on research and development, based on its view that money used for R&D and brand promotion shouldn’t be treated as expenses in accounting. “Our point of view is that this is ridiculous because for tech companies, pharmaceutical companies, consumer companies, that should really be their biggest asset,” said McKenzie.

Similar to European equities, Japanese stocks have some of the widest gaps between the cheapest shares and the priciest. While the inexpensive Japanese shares have climbed in value recently, there’s still room for them to rise, according to Schlueter.

“This year we’ve seen some of those higher quality, higher returning companies start to outperform, for the first time in a decade” in Japan, said McKenzie. “There are opportunities for stock pickers given that there is a substantial valuation discount for the cheapest stocks in Japan,” and though the discount has narrowed, it’s still wide historically.

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