Hunting for Japanese quality stocks

Finding the rare gems of Japan’s corporate sector

Japan was known for decades to be a hunting ground for deep value stocks, meaning the companies were valued below their net liquidation value and here we are not talking about book value, but below the net-working capital position. This was the old classic Benjamin Graham, the mentor of a young Warren Buffett, yardstick for value, but has since disappeared because understanding of equity valuation has removed such rare deep value stocks. These opportunities only existed in the post 1929 crash market because investors were simply scared of stocks.

Fast forward to Japan in 2023 and investors can still go on deep value hunting, but this segment is what Warren Buffett would call looking for cigar boxes with maybe one last cigar puff. In general we would argue that it is more interesting to hunt for high quality companies and a good way to start is to isolate companies with a high return on invested capital as that is typically a signal of a strong business model and product.

The list below shows 14 Japanese companies with a ROIC above 20% and a market value above $5bn. One observation is that this group of companies is quite small given the size of Japan’s equity market but it underscores Japan’s long tradition for maintaining corporate intra-holding relationships and employment more than effectively using capital. However, as we highlighted in our recent notes the Japanese corporate sector is changing and has become much more efficient in its use of capital. For many foreign investors there will not be many recognizable names except maybe for Nintendo which is a household name in many countries due to its iconic gaming consoles.

Advantest advances on AI rally

One of the companies on our list of high quality stocks in Japan is Advantest. The company is Japan’s leading manufacturer of automatic test equipment for the semiconductor industry, and manufacturer of measuring instruments used in designing, production, and maintenance of electronic systems such as fiber optics and wireless communications equipment.

In a country known for low growth and inflation since the late 1980s, Advantest is a rare growth story that has grown revenue from $1.61bn in FY13 (ending 31 March 2013) to $4.14bn in FY23 while expanding the EBITDA margin from 6% to 34%. The combination of 10% annualised revenue growth and rapidly expanding margins are the two key factors behind the impressive 27.3% annualised returns over the past 10 years and 29.5% annualised returns if dividends had been reinvested in the stock. The AI-hyped rally in US technology stocks has spread like ripples across the global semiconductor industry and Advantest shares are up 128% this year.