Investment Opportunities

Is This Investment a Value Trap?

Warren Buffett turned 90 on August 30.

But it was investors who got a surprise.

On the same day, the Oracle of Omaha revealed that a Berkshire subsidiary had taken a 5% stake in five major Japanese trading houses.

With $146.6 billion in cash to spend, Berkshire’s cash kitty barely saw a dent from the $6 billion investment.

Still, Berkshire’s foray into the Japanese stocks marked a sea change in Buffett’s thinking.

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Buffett has often said he has trouble finding good deals in the U.S. After all, trendy tech stocks have driven U.S. indexes to all-time highs.

So you could see Buffett’s investment in Japan as the ultimate anti-FAANG stock statement.

It also invites an obvious question: Should you follow Buffett’s lead?

Buffett Goes to Japan

Technology has guaranteed the supremacy of U.S. stock markets over the past decade.

The U.S. stock market rally has been powered by growth stocks, ranging from Amazon (Nasdaq: AMZN) to Tesla (Nasdaq: TSLA).

And despite Buffett’s allergy to technology stocks, Berkshire’s single best investment of recent years, Apple (Nasdaq: AAPL), was a FAANG stock.

Meanwhile, investors have ignored the cheapest stock markets in the world.

A shift away from this requires a catalyst.

For American investors, that catalyst could be Berkshire dipping its toe into Japan.

Big-picture investment themes respond more to a shift in narrative than just numbers.

The smart money has placed contrarian bets on Japan for at least a decade.

Yet, in the absence of a shift in sentiment, Japan remained a value trap.

Recalling the Post-War Japanese Miracle

Japan wasn’t always in investors’ doghouse.

Veteran investors recall Japan was once the China of its day.

Japanese companies were both feared and admired. Mitsubishi (TSE: 8058) – one of Berkshire’s new investments – even gobbled up New York City’s iconic Rockefeller Center.

Bookstore shelves buckled under the weight of books touting Japanese management techniques.

The founder of Sony co-wrote a nationalistic treatise called “The Japan That Can Say No: Why Japan Will Be First Among Equals.”

Students at top U.S. business schools studied Japanese. A good friend of mine ended up running Salomon Brothers’ Tokyo office.

Coming out of Harvard Law School, I was even offered a position at a Japanese law firm even though I did not speak Japanese.

Making a Mint in the Japanese Stock Market

Global investment pioneer Sir John Templeton made a fortune by investing in cheap Japanese stocks in the 1950s.

Over the next 30 years, Templeton witnessed the Japanese stock market rise from obscurity to become the greatest stock market bubble of the 20th century.

Consider these statistics…

By early 1989, Japan accounted for 45% of the global stock market.

The U.S. followed with 33%.

In early 1989, the average price-to-earnings ratio for all stocks on the Tokyo Stock Exchange was around 58. That compares with the S&P 500’s 22 today.

Just $10,000 invested in Japanese stocks in 1982 would have grown to around $100,000 by early 1989. That works out to a return of 39% per year.

By 2017, Japan’s share of global stock market capitalization had fallen to 8.4%. Roughly half of all listed companies in Japan are trading below book value. The world’s third-largest stock exchange is all but a pariah.

Berkshire’s Bet

So let’s take a closer look at Berkshire’s investments.

To recap…

Berkshire bought roughly 5% stakes in each of the following Japanese trading companies: Mitsubishi Corp., Itochu Corp. (TSE: 8001), Mitsui & Co. (TSE: 8031), Sumitomo Corp. (TSE: 4005), and Marubeni Corp. (TSE: 8002).

Their business models are surprisingly similar to Berkshire’s.

Berkshire has holdings in energy, mining and consumer goods. Sometimes it owns companies outright. Other times it takes smaller stakes.

Like Berkshire, Japanese trading companies have a portfolio of businesses and investments. They have been described as a cross between private equity funds, venture capitalists and asset managers.

Mitsubishi owns one-fifth of the eponymous Mitsubishi Motors Corp. as well as oil and gas fields off Russia’s Sakhalin Island.

Itochu owns Dole Food.

Marubeni owns an automotive parts sales business in the U.S.

Mitsui has investments in Singapore-based DaVita Care, a subsidiary of Berkshire-backed dialysis clinic operator DaVita in the U.S.

Each trading company scours the globe for investing opportunities. Together they have spent more than $50 billion over the past five years.

A Textbook Berkshire Investment

Investing in Japanese trading companies is a textbook Berkshire investment.

Put simply, Japanese trading companies are cheap, are unpopular and pay healthy dividends.

First, all except Itochu were trading at 0.75 times book value or less when Berkshire bought them.

Second, trading companies pay a high dividend. For example, Sumitomo expects to pay a dividend of about 5%.

Third, in a world dominated by go-go growth stocks, trading companies are solid, undervalued stocks with steady profitability.

The question remains: Should you join Buffett?

On the one hand, Berkshire’s investment in Japanese stocks could be the catalyst for a long-overdue turnaround.

On the other, Japanese stocks have been cheap for more than a decade.

And so far, they have proven to be value traps.

My advice?

If you do bet on Japan, keep your bet small.

And hedge your currency risk through an ETF like the WisdomTree Japan Hedged Equity Fund (NYSE: DXJ).

Good investing,

Nicholas


About

An accomplished investment advisor and widely recognized expert on quantitative investing, global investing and exchange-traded funds, Nicholas has been a regular commentator on CNN International and Fox Business Network. He has also been cited in The Wall Street JournalFinancial TimesNewsweek, Fox Business News, CBS, MarketWatch, Yahoo Finance and MSN Money Central. Nicholas holds a bachelor’s and a master’s from Stanford University and a J.D. from Harvard Law School. It’s no wonder his groundbreaking content is published regularly in the free daily e-letter Liberty Through Wealth.

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