Japan: The Land of the Rising Profits

Executive Summary

Japanese profits have benefited from the prolonged deleveraging of Japan Inc. The reduction in debt coupled with exceptionally low interest rates has allowed cash flow to impact the bottom line. This has been the major engine of the increase in Japanese profitability that we have witnessed, not some Damascene conversion of Japan Inc. to the cult of shareholder value maximisation (SVM). The Japanese equity market has continued to de-rate despite the improved fundamentals, which creates a potentially very interesting opportunity for investors.

In my last two missives – The Curious Incident of the Elevated Profit Margins and Slow Burn Minsky Moments (and what to do about them) – I touched upon Japan, amongst other countries. In this note I wish to take a deeper dive into Japan and the potential it may offer the value investor today.

japenese profits

So, what is behind this notable shift in corporate profitability? One of the oft heard refrains is that Japan has undergone a Damascene conversion and suddenly “got the religion” of shareholder value maximisation (SVM). Given my published view of SVM as The World’s Dumbest Idea, you might colour me skeptical of this particular explanation.

The Beautiful Blade of Occam’s Razor

Thankfully I don’t have to resort to using the mantra of SVM to explain what has been going on. Whilst I am sure that some companies have indeed become more shareholder-aware, I think there is an altogether simpler explanation for what we have seen in Japan.