TOPIX is cheap; when will investors start to care again?

by SR on June 28, 2012

TOPIX average price-to-book ratio for all 1st and 2nd section stocks

I had a drink with a friend who is an investor in Japan and Asia-ex-Japan the other night and inevitably we ended up talking about the markets. They are, we agreed, appalling and Japan has been especially neglected. He commented that five years ago you would have been happy to pay a forward PE multiple of 15x for a quality stock with prospects, like Denso. This year, if the earnings forecasts I discussed in detail in this post are at all accurate, Denso is trading on a little over 10x FY3/13 earnings – and FY3/13 results are only 9 months away! The world’s largest listed auto parts supplier, having a great year and likely to have an exceptionally good first quarter, is basically being ignored.

“There’s value in Japan” ruminated my drinking partner, “but nobody cares”. I have to admit that, until the European mess is cleared up, I agree with him. My instinct is that many industrials are cheap, especially auto-related stocks. Rather than focusing only on industrials I thought I’d quickly check the basic valuation metrics for the market as a whole, in the shape of averages for the TOPIX first and second section stocks. As the chart above shows (click for a larger image), the market as of the end of May 2012 was within a whisker of its lowest price-to-book level of modern times. That low of 0.65x was set in February 2009 at a point when the financial crisis had crushed share prices but when reported book value per share had not yet been affected. As of the end of May 2012 the PB ratio was 0.71x – just a smidgen above trough values. (Incidentally the EPS and BVPS data is taken directly from the Tokyo Stock Exchange’s calculations.)

The chart below (click for a larger image) shows the same thing through the lens of the price-to-earnings ratio for the market as a whole. Methodologically speaking this is trickier to deal with as profits have been negative during certain periods of the past, so I have set negative values to zero and capped values at 100x. Still, the story seems similar. The trough value of 12.4x was set in February 2009 – again, this was share prices reacting ahead of the impact on reported earnings – which is noticeably lower than the 15.4x of May 2012. Still, the PE is more volatile than the PE, so we would expect a larger gap. On a forward basis there are good reasons to expect solid profit growth in FY3/13 after the turmoil of FY3/12, so I would expect that 15.4x to come down, all other things being equal. And this is for the market as a whole, which includes a great deal of dross. There are quality stocks in there trading at much lower valuations than the average.

The real question is, when will investors feel they can afford to take a view that involves committing to positions for more than a few weeks? Until that happens, very few will buy stocks on future earnings.

TOPIX average price-to-earnings ratio for all 1st and 2nd section stocks

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