This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Brett Moshal, portfolio manager at Orbis, looks at Japan’s high-yield stocks.
Value investing — buying cheap stocks — works better in Japan than it does elsewhere, and it works far better in Japan when the spread between cheap and expensive shares is wide. Today, that spread is at its widest level in nearly 20 years.
Traditional “value” typically refers to stocks that trade at a low multiple of their book value. But there are other measures. Recently, one that has excited us is dividend yield. Today, the Japanese market offers a dividend yield of above 2%. While that’s not high compared with the UK market, it is high vs historical levels in Japan, and the yield on Japanese shares is more attractive than it has ever been vs the yield on local government bonds.
This opportunity has emerged because high-yielding stocks are contrarian in Japan today, having lagged the market significantly in 2018.
The usual reason for a high-yielding stock to underperform is that investors doubt the company’s ability to maintain its payouts. For some companies, that doubt is justified. But for the businesses we’ve researched, our analysis suggests that not only will our favoured high-yielding companies maintain their payouts, but they will grow them as well. Some hold net cash on their balance sheets, and most have ample scope to pay out more of their earnings.
Like other value factors, dividend yield has worked well in Japan, outperforming in all but a handful of rolling four-year periods. The recent bout of underperformance is an exception. It is the worst run for high-yielding shares in over 20 years.
That’s intriguing to us, in part because high-yielding shares have also had lower risk characteristics than the wider market. Since 1975, high-yielding shares have tended to fall less than the market when the market is down. In industry speak, they have a lower “downside capture” ratio than other shares.
Exciting Opportunities Unusual at this Stage
That makes sense. A stock trading at 1.6 times book value may well dip to 0.8 times if pessimism is extreme, but the market is less likely to let the price of a 4% yielding stock fall until the yield reaches 8%. So long as one can build conviction that a dividend is sustainable, Japanese companies rarely trade with a dividend yield above 5%. When we ran the numbers for the largest 500 stocks in Japan, just 10 of them yielded more than 5%.
This provides a cushion on the downside — but also ordinarily limits the opportunities to buy such companies at a steep discount to their intrinsic value, which is how we invest. Because dividends are highly visible and well appreciated by investors, companies with substantial dividends often end up fairly priced. In the US, for example, high-yielding shares have barely outperformed the wider market over the long term.
It’s particularly unusual to find attractive ideas among high yielding shares on the heels of a long bull market. At market peaks in 1990, 2000, and 2007, the TOPIX yielded just 0.5%, 0.5%, and 1.1% a year, respectively — and each time, the market offered a much lower yield than Japanese Government Bonds (JGB). Today it is a very different story. While 10-year JGBs offer essentially zero yield, the Japanese stock market yields 2.2%.
The opportunity in Japanese high yield shares looks exciting. But we don’t care about yield for its own sake — as we’re not traditional value investors, we only care if a stock’s yield suggests a discount to the company’s intrinsic value. Lately, that’s exactly what we’ve seen. An unusual number of our favourite shares also offer high dividend yields: industrial conglomerates Mitsubishi and Sumitomo, tyremakers Bridgestone and Toyo, mobile network operator KDDI, and selected home and apartment builders.
In short, we believe the Japanese market is offering opportunities to buy decent businesses at good prices, with high yields that could give the shares lower-risk characteristics. In our view, that’s an attractive combination.
Morningstar Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar.
