Thinking Points
- Many investors looking into Japan focus on net-net screens, but probably want more.
- There is a lot of free valuable information packed into Japanese filings if you know where to look: One is foreign ownership data.
- With foreign ownership data, you can get a feel for how familiar other foreign investors are with a Japanese company’s story.
Occasionally, I get the question “How do you screen for Japanese stocks?” to which my typical response is either “I don’t” or “I read Japanese articles on the internet and pick out companies that sound interesting to me”.
I have since realized that my answers weren’t particularly helpful, so I did some thinking. I could tell you to run a Ben Graham style net current asset value (NCAV) screen, but I’m fairly certain you’ve already done that.
When you ask about how I screen for stocks, you were probably wanting to know more about how I generate ideas. For the most part, reading articles on the internet in Japanese is how I start, but there are several other things that I take a quick look at; one of which I will share today.
Foreign Ownership
Late last year at Tokyo Narita Airport, I had coffee with a couple of my readers, one of whom is a fund manager (and Premium subscriber!). Let’s call him Jay. We talked about everything from idea generation and research process to more personal-level things like cultural observations.
Curious about how non-Japanese speaking investors assess company quality for a Japanese firm, I picked Jay’s brain a bit. The first bit I got was that he is highly familiar with accounting, and Japan’s specific peculiarities in accounting. However, what occupied more of my thought afterwards was a casual remark he made toward the end of our conversation:
“ I get a little excited when foreign ownership is below 5%”
– Jay (pseudonym)
Okay, I don’t exactly remember if he said 5%, 10% or 12.37528%. But the point is that he gets a little excited whenever he discovers that foreigners don’t own much of whatever Japanese firm he is interested in.
Why could that be?
I think part of it is being one of the first to uncover an opportunity set. Frankly, the stories of some of Japan’s best companies are well known to the world. Often times, the company’s high quality is already priced in.
Let’s take Fanuc (TSE: 6954), which I wrote about last week, for example. For those of you who have never heard of Fanuc, the company is a global leader in industrial robotics and CNC (computer numerical control) systems.
As of March 2017 (fiscal year end for Fanuc), foreigners owned 54.2% of Fanuc stock. Today, the company trades at 31 times price-to-earnings (P/E) and 3.7 times price-to-book (P/B). Compare this with Nikkei 225’s P/E and P/B multiples of 15.06 and 1.32 as of December 29/2017, and you can get a feel for Fanuc’s investor sentiment.
Of course, Fanuc is a leading company with high operating margins (30%+) in a growing robotics industry. Add the 518 billion yen ($4.9 billion USD) net cash balance sheet (about 10% of market cap), and you can see why investors remain confident.
The point here isn’t so much about Fanuc’s intrinsic or market valuation, or where it should or should not be. Rather, it is whether the world knows the Fanuc story or not.
I think everybody can agree that if there is a solidly stable business and you are one of the first to figure out the opportunity set, your odds of doing well are pretty good. As our friend Warren Buffett would say:
“What the wise do in the beginning, fools do in the end.”
– Warren Buffett
To be sure, I’m not dissing new Fanuc investors. I’m merely pointing out that Fanuc’s story is well known and investor sentiment, along with market valuation, seems elevated.
This isn’t specific to Fanuc either. Take a look at other leading companies like Keyence (TSE: 6861), Ryohin Keikaku (TSE: 7453), or Shinetsu Chemicals (TSE: 4063) for more examples:
As a point of reference, foreign ownership of stocks traded on the Tokyo, Osaka, Nagoya, Fukuoka, and Sapporo exchanges combined floated around 30% over the past 5 years (Japanese source).
Don’t reach for your wallet
I’m sure foreign ownership information comes as a part of expensive financial databases, but you can get this information for free. As far as I can tell, it takes a little bit of work for non-Japanese speakers.
- Go to EDINET’s English portal. (This is the Japanese equivalent of the US SEC EDGAR database).
- Click on menu item “Document Search”:
Source: EDINET
- Enter the stock ticker number in the “Document submitter / Securities issuer / Fund information” field and make sure the “Annual Securities Report / Semiannual Securities Report / Quarterly Securities Report” field is checked. In this example, I used Fanuc’s ticker number 6954:
- Scroll down and click on “Search”.
- Click on the most recent Annual securities report:
- This is where the EDINET system needs a little “umph”. The user interface is in English, but the filings are all in Japanese. This is where I come in. The stock ownership distribution is presented in Section 4.1.(6):
Section 4.1.(6) will send you to a chart that looks like this:
Okay, so this probably looks like a bunch of gibberish for most people, but I highlighted the parts about foreign ownership.
What to do now
Taking a quick look at foreign ownership information has always been a part of my research. This isn’t so much because I had the novel idea of looking into it specifically, but because the Nikkei company page has a tab dedicated to stock ownership information. Until Jay made his casual remark, I didn’t think much of it.
In looking for not-yet-discovered opportunities in Japan, it’s important to be aware of what the other foreigners are doing.
A few things to keep in mind are:
- Japanese institutional investors are short-term oriented.
- You are probably long term oriented.
- You are probably a foreigner.
Essentially what I am getting at here is that there is a time arbitrage angle (i.e., short-term oriented Japan) along with a way to gauge your competition (i.e., foreign ownership information).
According to a Misaki Investments presentation from September 2016, over 90% of institutional investors had holding periods of less than a year. I doubt much has changed in the last year and a half. I am also doubtful that this same group of investors are paying much attention to long-term value investing concepts like intrinsic value. Given that, finding a solid Japanese business with low foreign ownership may provide you with a nice watchlist.
Somewhere pretty early in your research process, it may be worthwhile to check foreign stock ownership in the company you are researching. 30% foreign ownership is a good benchmark, however, I’d expect a larger percentage for larger, more familiar companies and smaller percentage for smaller, less familiar companies.
Take SHOEI (TSE: 7839) as an example. The company is known for making some of the world’s top premium helmets. You may have discovered this fact recently and decided to take a closer look. You are staring at a healthy operating business (20+% Op. Margins) with a fine balance sheet (Equity/Asset of 0.83) still in small cap territory with a 61 billion yen market cap ($570 million USD). So far, so good, except for the fact that foreigners already own 32.9% of shares (as of September 2017, Nikkei). That seems like a high figure for a small company. Maybe the other foreigners already know the story.
Companies like Suzumo Machinery (TSE: 6405) and Weathernews (TSE: 4825), on the other hand, might be interesting:
Some may say the EV/EBIT ratios above are too high for Japan. The point here is the two companies are high quality industry leaders with low foreign ownership. Maybe foreign investors know the story, but are price-sensitive.
The bottom line
With Japan still being a mysterious place to much of the western world, it can be difficult to gain an edge as an investor. By the time you hear about Japan’s leading companies (like Fanuc), it’s often too late and everybody’s already heard about it. By looking up publicly available foreign ownership information, you can get a feel for whether other foreigners are familiar with a company’s story. Now go find some undiscovered opportunities!
