Geoff Gannon March 16, 2011

Buy Japan

I haven’t posted to the blog in a while. But the situation in Japan – and Japanese stocks – is definitely worth coming out of hiding for.

No matter how bad the nuclear situation gets, the earthquake and the events that followed will probably be classified by history as:

  • A major human disaster
  • A moderate economic disaster
  • A minor investment disaster

Public companies in Japan have already lost more value in terms of their market caps than could ever be justified by the disaster – no matter how bad the nuclear situation gets – because there’s no way these companies’s future cash flows could be permanently impaired to the degree necessary to cause a loss in intrinsic value equal to their recent loss in market value.

And Japanese public companies were already some of the world’s cheapest businesses. So some of the world’s cheapest stocks just got cheaper.

Some folks are going to argue that the disaster in Japan – and subsequent stock sell-off – provides an opportunity to buy stocks elsewhere. Ignore them. U.S. stocks aren’t cheap. Japanese stocks are. Don’t get fooled into buying stuff on the other side of the world. Go straight for the center of the crisis. Buy there. That’s where the bargains are.

There are lots of problems in Japan.

And I’m going to be brutally honest about them here. Seeing the human tragedy in Japan is something we can mourn as fellow human beings. But it shouldn’t color our view of Japan as investors.

I don’t like most Japanese businesses. The country’s business culture is toxic. It is very shareholder unfriendly. Returns on capital are – and frankly, have always been, even in the boom years – completely unacceptable. Most Japanese companies pander to their customers and do not price their products at the best levels for their shareholders. Japan is an investment basket case. And Japanese stocks deserve to trade at lower price-to-book ratios than the rest of the world’s stocks now and forever.

Having said that, I’m going through the Tokyo Stock Exchange and finding dozens of bargains.

Examples include grocery stores, logistics companies, and gas utilities. Some of these companies – unlike the vast majority of Japanese businesses – earn unleveraged returns on invested capital equal to their counterparts in the United States and Europe. Of course, they are all irrationally underleveraged. Many Japanese companies are.

There are tons of net-nets in Japan.

Some of these companies deserve to remain net-nets forever. Such justifiably permanent net-nets are very rare in the rest of the world. In the U.S., I can name – at most – about half a dozen net-nets that are consistently profitable but have such consistently pathetic returns on capital to deserve a fate of staying a net-net forever. One American example is Duckwall-ALCO (DUCK).

Economists may argue this has to do with Japan’s economic circumstances. I’m more inclined to believe Japan’s economic circumstances have been exacerbated by its business culture.

The profit motive is very weak in Japan.

Traditionalism – in the sense of non-profit driven economic relationships – is very strong in Japan.

Thinking of Japan as just another developed economy would be like thinking of the pre-war Southern states as being just another place in the U.S. They weren’t. They wove their economic bonds together in different – non-capitalist – ways. Tradition trumped profit. And they were a people apart from the rest of the developed United States.

Same thing in Japan.

Japan doesn’t have plantations. But it does have business relationships based more on tradition than profit. The financial reports of most Japanese companies make this very clear. The numbers scream it out at you. They tell you this ain’t a for-profit enterprise you’re looking at.

To call Japan a capitalist country strecthes that term to the breaking point. Japan’s economy is organized around relationships that are only partially concerned with profits. Companies are often content with meager profits. They may not accept losses. But they do not insist on adequate returns on capital. They regularly venture into operations that will never pay back the capital investment required. All of this is obvious from perusing the financial reports of public Japanese companies. There’s no history, sociology, or macro-economics involved in this assesement. It’s presented – quite obviously – in the company reports.

Japanese companies are not super inefficient. They’re just super concerned with all sorts of things that don’t lead to squeezing the last drop of profit out of their operations.

Japan is barely a capitalist country.

So dosing the patient with the same Keynesian medicine that works in countries with a strong profit motive doesn’t spur animal spirits in the same way. Japan’s problems are much worse than they appear. It’s the country I’m normally least eager to invest in. It’s definitely the most investor unfriendly place on the planet – excluding a few countries that seize private property. Other than those, Japan ranks dead last in attractiveness to investors. And it’s harder to overthrow a culture than a government. So, Japan is one of the most economically hopeless places on Earth.

But now is the time to buy Japanese stocks.

You can buy them indiscriminately if you want. I won’t. But you’ll probably hear I bought one or more Japanese stocks very soon.

You can diversify across 5 or 10 Japanese net-nets if you like.

Or you can buy an ETF. Or you can pick just one stock.

Whichever way you do it, do it soon.

If you’re an investor who spends hours and hours every week bargain hunting in the U.S. and around the world – my  advice is to drop everything and focus 100% of your time on Japan’s cheapest stocks.

The truth is that fortunes – big and small – are made on only a few investment decisions. And the big opportunities come around very, very rarely.

Looking back at the last 27 months of my own performance – since the start of 2009 – I see that only 3 of my investment decisions really mattered. In other words, all the work I did boils down to making one good decision every 9 months.

Two of those decisions were about loading up big on specific stocks. The other decision was being 100% invested in the best American companies I could find at the market bottom in early 2009. Beyond that – all the research, all the stockpicking, hundreds of hours of work – yeah, none of that really meant anything. If I’d picked my 8th best idea instead of my 4th best idea or the company’s closest competitor or whatever – the results would’ve been pretty similar. Only 3 decisions really turbocharged my investment results in a way that had nothing to do with what would’ve happened anyway if I’d picked the next best option.

That’s often how it works. You make most of your returns by seeing a few big opportunities and seizing them.

Japanese stocks are a once in a lifetime bargain.

Buy them.

Talk to Geoff About Japanese Stocks