Thinking Points
- An increase in buying demand through index inclusions is relatively common knowledge among well-known indices like the S&P 500.
- Western investors probably have not looked into similar approaches for Japanese indices, like the Nikkei 225 and TOPIX, which track the First Section of the Tokyo Stock Exchange.
- Paying attention to the early signs of potential uplistings may provide interesting opportunities.
Index inclusions drive buying demand as many financial products are linked to indices. There’s even a term for the elevated buying demand when a stock is newly included in the S&P 500: The S&P phenomenon. This is common knowledge, but I’ve never heard of a western investor taking a similar approach in Japan, so I figured I’d look into it.
A bit about the two big indices in Japan – Nikkei 225 and TOPIX
Japan’s two most common indices are the Nikkei 225 and TOPIX. The Nikkei 225 is maintained and calculated by Nihon Keizai Shimbun (business news publisher) while the TOPIX is maintained and calculated by the Japan Exchange Group (which also runs the Tokyo and Osaka exchanges). Just like the S&P 500 index, the Nikkei 225 and TOPIX indices both have numerous linked financial products.
Though the information is publicly available (even in English! – Nikkei 225, TOPIX), most investors probably are not aware that both Nikkei 225 and TOPIX indices only consist of companies traded on the First Section of the Tokyo Stock Exchange.
The Nikkei 225 is a price-weighted index which picks 225 stocks listed on the First Section of the Tokyo Stock Exchange. On the other hand, TOPIX is a free-float adjusted market capitalization-weighted index that is calculated on all domestic common stocks listed on the First Section of the Tokyo Stock Exchange.
It is difficult to determine which stocks get picked for Nikkei 225; apparently it is based on “liquidity” and “sector balance”. On the other hand, when a company is listed on the First Section of the Tokyo Stock Exchange, your typical TOPIX index fund automatically buys shares.
In July of 2017, Nikkei published an article mentioning Japan’s Government Pension Investment Fund’s (GPIF) TOPIX focused domestic equity portfolio. When the article was written, the GPIF had about 30 trillion yen ($282 B USD @ 1 yen = 0.0094 USD) allocated to domestic equities (most of which was pegged to TOPIX). As a reference, the total market capitalization of the First Section of the Tokyo Stock Exchange was at 596 trillion yen ($5.6 T USD) at the end of July 2017. Assuming 100% of the GPIF domestic equity portfolio was pegged to TOPIX, the GPIF alone would’ve accounted for 5% of TSE First Section’s total market cap.
I didn’t go through and aggregate all of the TOPIX index funds, but GPIF’s deal was enough to convince me that a new TSE First Section listing warrants a closer look.
How to get listed on the First Section of the Tokyo Stock Exchange
The obvious path to a First Section listing on TSE is an IPO. Here are the listing requirements:
Source: Japan Exchange Group
Notice that aside from the First Section, we have the Second Section of TSE, Mothers, JASDAQ Standard, and JASDAQ Growth. Here is a bit of information on each of the other sections.
Second Section – Basically the entry level main market section.
Mothers – This is actually an acronym which stands for “Market of the high-growth and emerging stocks”. As the name expresses, the focus is on the up and coming companies. Notice that there isn’t a profit requirement for this section.
JASDAQ – As you can see, JASDAQ is separated into two sections: the more established “Standard” section, which has a profitability requirement, and the up and coming “Growth” section, which doesn’t have a profitability requirement.
Here are the number of companies listed in each section:
Source: Japan Exchange Group
Forget about the First Section IPO
What I want to focus on is more about “Section Transfers” from other sections to the First Section of TSE rather than the more obvious, well-covered IPO.
Why? Because the First Section listing requirements for section transfers are more relaxed than a straightforward IPO.
The details of reassignment can be found here, but I outlined the key differences below:
Assignment to First Section from Second Section:
- Tradable shares
- A. 4,000 units or more (vs. 20,000 units)
- B. Market capitalization* of 2,000 million Japanese yen or more (vs. 1,000 million JPY)
- Trading volume
- Last three months trading volume minimum of 200 units per month (vs. no requirement)
- Market Capitalization* of 4 billion yen or more (vs. 25 billion JPY)
* Note that there are two separate market capitalization requirements on the basis of tradable shares AND listed shares.
Assignment to First Section from Mothers:
- Tradable shares
- B. Market Capitalization of 2,000 million Japanese yen or more (vs. 1,000 million JPY)
- Trading volume
- Sales basis** – Last three months trading volume minimum of 200 units per month (vs. no requirement)
- Market cap basis** – no requirement
- Market Capitalization
- Sales basis – 4 billion yen or more (vs. 25 billion JPY)
- Market Cap basis – 25 billion yen or more (vs. same requirement)
- Existence of Board of Directors and 3 years of operation
** Note – There are two approaches of reassignment from Mothers to First Section: One is based on sales and the other is based on market capitalization.
Assignment to First Section from JASDAQ:
- Existence of Board of Directors and 3 years of operation
Now, companies cannot IPO on the Second Section on Monday then move up to the First Section on Tuesday. There is a timing requirement:
Source: Japan Exchange Group
Interestingly, the Mothers listing has a 10 year rule. Once a company is listed on Mothers for 10 years, the company is reviewed. Essentially, if the company meets the on-going criteria for the Second Section, the company can either stay on Mothers or switch to the Second Section. If it falls short, it can get delisted. If it meets criteria for the First Section, it can switch to the First Section.
Pay attention to… gift giving?
My general belief is that value is its own catalyst, but with the way these listings (and its linked financial products) are structured, it’s hard to deny the fact that a First Section listing comes with benefits. Incorporating this into your value investing approach ought to yield some interesting opportunities.
Go back and take a look at the listing requirement for each market/section. The first criteria is the number of shareholders. In order to list in the First Section, a company needs 2,200 shareholders. To get to the Second Section, 800. Mothers and JASDAQ only require 200.
Now look at the timing requirements. A company can IPO on JASDAQ and switch to the First Section in 6 months. For Second Section and Mothers-listed companies, it takes at least a year. If a company wants to get to the First Section quickly, it needs to figure out how to increase its shareholder count.
Long-time Japan investors are probably familiar with this, but many of the publicly listed Japanese companies offer what I like to call a “dividend variant”. The Japanese term for it is Yu-tai (pronounced you-tie). These are generally gift boxes, gift cards, and coupons. Personally, I prefer dividends, but the idea is to entice more investors to own shares. In Japan, you have entire investment blogs that go on and on about which stocks offer the best gifts.
Why does this matter? Because when a company is trying to get listed on the First Section, it needs 2,200 shareholders. If you find a long-time Second Section-listed company starting to offer gifts that it previously hadn’t, it might be a hint.
As an example, Fulltech (TSE: 6546), a company that installs, sells, and maintains automatic doors, has been listed on the Second Section of the Tokyo Exchange since March 22, 2017. The one year mark is right around the corner. It clears all the hurdles for a section transfer to the First Section, except for the shareholder count requirement (as of March 2017 reporting).
In May 2017, the company announced its own gift: a 1,000 yen gift card for every 100 shares owned. In the same announcement, the company offered a separate one-time 1,000 yen gift card as a celebration for its Second Section listing. In mid-February, the company announced an off-floor distribution of 200,000 shares in relatively small lots (max: 1,000 shares), which was completed earlier this month. At this point, the company already explained it is in the process of applying for First Section listing.
In Fulltech’s case, paying attention to its uplist potential would’ve paid off handsomely:
Source: Google
How can you spot these opportunities?
The Japanese Exchange Group is kind enough to give us a neat list of newly listed companies… in English!
As for checking the number of shareholders, refer to an article I wrote last month about how to spot foreign ownership. In the article, I explained how to look up foreign ownership information. You can get the total number of shareholders using the exact same steps.
Here is a screenshot from my the article:
Source: EDINET
In the example, I looked up Fanuc’s (TSE: 6954) ownership information.
If you get bored of going through Japanese net-net screens, give this approach a try!
