Whither Japan Stocks: At 7% ROE, the Market has a Bottom

Businessmen walk in front of an electronic board showing the Nikkei 225 index at the Tokyo Stock Exchange in Tokyo on January 20, 2012. Tokyo stocks rose 1.33 percent Jan 20 morning as a firming euro helped export issues gain ground, brokers said. The Nikkei 225 index at the Tokyo Stock Exchange gained 115.03 points to 8,754.71 by the break after topping the 8,700 mark for the first time since early November. (Image credit: AFP/Getty Images via @daylife)

?Japanese stocks are cheap!?? Have any four words led to more dashed hopes?and foregone profits from investing elsewhere, if not losses?than these?? ?This time it?s different,? you will reply.? Okay, but you get what I am saying.

As I write in the morning of May 16 Tokyo time the Nikkei average is off 80 points to 8821, a new multi-month low. ? The Nikkei fell below 9000 on May 11. ? It is now much closer to its YTD low of 8378 hit on January 16 that its high of 10,255 reached on March 27.? Having risen sharply from a low point reached on February 1, the Nikkei 60 day moving average is now heading down:? a bearish indicator for the near term.

Still, or because, valuations are getting a lot better.? For stocks on the Tokyo Stock Exchange (TSE) First Section, today?s stats are:? price-to-book 0.93x; PER 19.6x trailing/12.1x forward; EPS 5.09% trailing/8.25x forward; dividend yield 2.26% trailing/2.3% forward.

What is attracting particular notice is rising ROE.? Yesterday?s Nikkei Keizai Shimbun carried an analysis showing that TSE 1st section companies have recorded a 62.8% jump in net income for the past fiscal year (ended March 31). ? The big improvement is off large declines or losses caused in part by the 3.11.11 tsunami/earthquake disasters, power interruptions, and Thai floods, as well as historic yen strength.? But it is a real improvement, showing that Japanese companies can and do restructure and adjust to changed circumstances.

What matters most for the market may be ROE, which as of May 14 had risen to 7.4% for all 1st listed companies. ? This is a high level for Japan.? According to market analysts quoted by the newspaper it is also higher than the 7% cost of equity capital assumed to prevail in Japan.? This suggests that the market has reached a bottom and is poised to rise in line with continued improvements in company performance.

The price-to-book ratio of 0.93x?i.e., the whole of Japan?s largest companies selling for less that book liquidation value?has not often been seen.? This is another indication of market?s cheapness.? But what of individual stocks?

Japan?s major banks all released FY12 earnings reports during the past few days.? The top lines were all very good.? Mitsubishi UFJ Financial Group (NYSE: MTU), my favorite, announced earnings up 68% to JPY 981.3 billion (USD 12.3 billion), the best performance in many years.? The not-so-good news is that JPY 270 billion of the earnings (up from JPY 221 billion in FY11) were from securities trading?mainly of JGBs.? The bank president, Nagayasu Katsunori, told investors yesterday that?with 10 year JGBs yielding 0.84%?he does not expect big increases in earnings from this source going forward. ? Another source of non-recurring accounting earnings was JPY 291 billion from converting preferred shares of Morgan Stanley into common.

Even adjusting for the one-offs, MTU?s earnings were the best for five years.? What about the future?? The company?s Medium Term Plan plots growth and profits from two key strategies:? 1.? build upon and exploit its franchise as Japan?s ?leading Asian regional bank?; and 2. leverage and exploit marketing and operational synergies within the MTFG ?group.?

I like both these strategies, especially the first. ? MTU was formed from a merger of Japan?s strongest bank, Bank of Mitsubishi, core bank of its strongest industry group, and Japan?s leading international bank, Bank of Tokyo.? BOT possessed an unmatched (for Japan) international network and expertise, and these remain key competitive strengths of MTU.? The Medium Term Plan calls for the bank to target and provide services for out-of-region customers (e.g., customers of Union Bank in California) with needs within the region. ? It is a strategy very much within the competitive capabilities of the bank.

Is MTU cheap?? I would say so.? In today?s slightly down Tokyo market the group stock is trading at JPY 347, off 0.57%.? At this price, the PBR is a ridiculous 0.49x.? The dividend yield is 3.44% and EPS yield 19.87%, both attractive.? The ADR closed yesterday at USD 4.33, down 0.47%.? The 52-week hi/lo is $4.01/5.36.

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