Thinking Points
- Here’s the second takeaway from my recent Tokyo trip: Shareholders matter.
- Japan has a different way of looking at corporate ownership. Knowing the other shareholders and what influences them ought to help in uncovering your next idea.
- Motivated individual investors can find growth at very reasonable prices where fund managers can’t reach.
In case you missed it, this is part 2 of my series covering a few things I’ve learned during my Tokyo trip with a fund manager. Part 1, which you can find here, focused on management quality. We discussed how even a high quality company that can be run by a ham sandwich still needs someone calling the shots on capital allocation decisions. Today, we’ll talk about the second takeaway: Shareholders Matter.
Shareholders Matter
Here we go with another blatantly obvious statement. But in order to find success investing in Japan, understanding what it means to be a shareholder is integral.
Now maybe you’re thinking, “What on earth is this guy talking about? Shareholders own the company. We decide where the company is headed and vote on whether management gets to stay or not.” And that’s entirely true.
In Japan, however, corporate ownership is generally perceived a little differently than most of the western world. Employees have ownership of the company too, just not on paper. We’ve discussed this in a previous post, highlighting how T. Boone Pickens got burned. In that post, I quoted a 1992 Chicago Tribune article written by T. Boone Pickens himself:
“Three years ago I purchased a 26 percent interest in Koito Manufacturing, a large Japanese auto-parts maker. At the time, I knew little of the keiretsu system, but I saw an opportunity to profit and, at the same time, help the company move into the global marketplace. My goal as largest stockholder was to gain a seat on Koito’s board of directors. I naively thought it was a reasonable request, since Koito`s second-largest shareholder, Toyota Motor Co., was awarded three board seats for its 19 percent ownership stake. Wishful thinking on my part. Despite a 2 1/2-year effort, the Japanese denied what in American corporations is considered a right.”
– T. Boone Pickens, Chicago Tribune (emphasis added by me)
Source: T. Boone Pickens in Japan back in the day – Nikkei Asian Review
While Mr. Pickens was the largest shareholder, Toyota was an even bigger stakeholder. Now it makes sense that active investing in Japan yields mixed results. We even met with a gentleman who provides shareholder identification services to corporations. He noted Japanese managers are particularly concerned about active investors.
Who are the other shareholders?
For most of us managing our personal investments, fighting for board seats and voicing our opinions aren’t practical options. This section will be more useful than the last.
First, I’ll clarify that the fund manager I went on a trip with is the same guy that I quoted in a previous article:
“ I get a little excited when foreign ownership is below 5%”
– Jay (pseudonym)
In the same article, I introduced a way for you to figure out a company’s foreign shareholder base using EDINET (Japan’s version of EDGAR). My line of thinking was this: If foreign ownership is low, the price is attractive, and the business performance is (or will be) there, then maybe we have an undiscovered gem.
And there is nothing wrong with this line of thought. During this trip, however, I watched “Jay” dig a little deeper into questions about shareholders.
Who are the major shareholders? What level of involvement do they have? Are they part of the founding family? How often do you have fund managers asking for a meeting? Are any of them foreign?
… and the list goes on. He asked about shareholders in every meeting except for one… because we went way over our allotted time with other questions and rush-closed the meeting.
When daily redemption is a thing, it’s a real risk for fund managers. They could be forced to sell off shares. A stable shareholder base would mean less chance of being stuck in a buyer’s market and forced to sell at an unreasonably low price. Of course, on the other hand, it probably also means there are fewer shares being traded in general, which means low liquidity…. In any case, being aware is half of the game.
As a reference, foreign ownership of Japanese companies listed on the Tokyo Stock Exchange has remained around 30% for the last few years according to the Japan Exchange Group.
What does this mean for individual investors?
Several thoughts came to my mind when thinking about this.
First thought is that there are many long-term value oriented fund managers who are forced to look at volatility as risk. Redemptions at the wrong time can be costly (and you better bet clients redeem when everybody is selling). This means fund managers need liquidity.
Second thought is that individual investors can leverage this need. If you’re an individual investor, chances are that you manage your own money. And you’re probably not planning to pull money from your portfolio to buy groceries. Let’s just say nobody needs to redeem anything. If this is the case for you, you’ve got opportunities.
Third thought is, how do we benefit from this?
After talking to a couple of fund managers and our kind friends at Fisco, I’ve concluded that companies start hitting the radar for fund managers when market cap lands between 100 and 400 million USD. And 100 million USD is really pushing it for some managers, especially those managing large, concentrated portfolios… it could takes weeks (and sometimes even months) to build a position of any significant size.
Then you sneeze the wrong way, punch an extra 0 into your order, and find yourself in a hostile takeover situation. Okay that doesn’t happen, but you get the idea.
So there are a lot of opportunities in that 100 to 400 million USD market cap range. The problem is that many of these companies only report in Japanese. And you’re probably better off investing in American companies rather than spending the next 20 years learning Japanese.
Frankly, I’ve already spent the better part of the last two years digging into some of these companies. It goes without saying that I found more than a few good ones – we’re talking growth at a very reasonable price. Like an EDI middleware market leader with remarkably high ROIC and a flood of free cash flow trading for a single digit EV/EBIT multiple. Another example is a continuously growing (albeit slowly… for 45 years in a row) child education service company, also with healthy free cash flow and ROIC trading for single digit EV/EBIT multiple.
Basically, we have a big basket of companies that aren’t quite reachable to most fund managers (yet), and no real way to take advantage with a language barrier. Now for a bit of shameless self promotion: I’ll be launching a service soon to address this problem for individual investors.
The bottom line
Understanding what it means to be a shareholder in Japan is integral in finding investment success. Moreover, a deeper understanding of factors that influence other shareholders’ behaviors helps to uncover opportunities. As an individual investor, the research process may be difficult without Japanese fluency, but you can still find growth at very reasonable prices where the fund managers can’t quite reach.
