Japan has been under the radar and undervalued, says Darius McDermott, managing director of FundCalibre and Chelsea Financial Services.
On the face of it, Japan’s economic recovery has been a bit like old school test match batting. Take your time, get your eye in and then start playing a few shots. It has been a slow build to growth since the bubble burst back in December 1989.
That’s what an optimist would tell you (we all know there are still plenty of Japan pessimists out there!). So I was pleasantly surprised when I read a recent market update from Matthews Asia which highlighted that over the past 15 years Japanese equities as an asset class have actually produced double-digit annual returns*. The average earnings per share (EPS) of the Japanese Topix has also grown as much as the S&P 500 for much of the past decade. Unfortunately, this has gone under the radar, resulting in low valuations and a lack of ownership within the region.
Japanese large-cap equities, as represented by the Tokyo Price Index (Topix), are currently trading on a P/E multiple of 13.1x 2025 forward earnings, 29% lower than the U.S. The same value is available on a price-to-book (P/B) basis, with Japan trading at just 1.4x, about a third lower than the average among the top developed equity markets and more than two-thirds lower than the U.S (4.8x)**.
Corporate governance evolution continues
It is now more than a decade since the late Shinzo Abe became prime minister and started to tackle low growth, rising debt and poor demographics with the introduction of his ‘three arrows’ approach of Abenomics. It was effectively a state-sponsored campaign which sought to improve both corporate governance and capital management.
Crucially it has continued to evolve. In 2023, the Tokyo Stock Exchange (TSE) pushed companies to focus on achieving sustainable growth and enhancing corporate value. It targeted companies that have consistently traded below a P/B ratio of one (over half of companies in the Topix in 2023). The move was designed to put further pressure on Japanese management teams to address issues of capital inefficiency. One of the main reasons for these low P/B ratios is cash in reserve.
The TSE is now looking to address child-parent listings (situations where a parent company and its subsidiary are both publicly traded). Companies are now aggressively buying back shares and dissolving old-world corporate shareholding structures.
M&G Japan manager Carl Vine cites the likes of Toyota Industries and its 9% shareholding in Toyota Motors. He calls it “a textbook example of a valuation distortion created by Japan’s labyrinthine cross-shareholdings”. Another is NTT attempting to acquire the remaining 42% it doesn’t own of NTT Data – one of the world’s largest data centre operators***.
Vine says the price offered will matter greatly on whether these deals are beneficial, saying minority shareholders must be fairly rewarded not only for the operating business but also for the embedded value in cross-holdings and dormant assets such as real estate. However, the change in rules is what really matters.
In April, Topix-listed firms announced ¥3.8 trillion in buybacks, nearly triple the ¥1.3 trillion from a year earlier. The total for the year has already reached ¥6.9 trillion, more than twice the level at this point in 2024***.
Beyond corporates – the macro remains promising
At a time when volatility and geopolitical uncertainty are rife, Japan also offers a degree of optimism from a macroeconomic perspective courtesy of inflation, rising wages and a changing attitude to risk. The first two are interconnected as we see an end to the pain of deflation (inflation was 3.5% in May 2025 having typically been around 2-3% in the past four years).
This should encourage consumers to be less sensitive to price rises. Japanese wages are also on the rise following the 2024 shunto negotiations, which take place each spring between labour unions and employers. Wages increased by over 5% for the first time since 1991 and gains are expected to be similar in 2025****.
However, arguably the most important of these has been the changing attitude towards risk, with more being invested thanks to more attractive annual limits being offered for the tax-exemption scheme for investment, also known as the Nippon Individual Savings Account. From January 2024, the tax-free annual investment limit will effectively double.
To put this into context – the average Japanese household has historically had over half their assets (53%) in bank deposits and only 13% in equities****. There is great scope to boost investment in Japanese companies through these attractive domestic investment schemes.
More to come and is a growth renaissance next?
Like most of the world, value companies have dominated growth over the past four years in Japan (the MSCI Japan Value index has returned 45.1% vs. 0.4% for growth)^. However, Comgest Japan Growth co-manager Richard Kaye says this highlights a lack of investor research and attention paid to the region.
Kaye says there are signs of value stocks starting to fade, highlighting Japanese financial institutions buying more Japanese stock (around 40% of the total share of the TSE). He says these investors are less interested in cyclical stocks, preferring companies which deliver consistent long-term growth^^.
Baillie Gifford Japan Trust manager Matthew Brett concurs on cyclical tailwinds fading and says he is finding a few exceptional companies in this environment. Examples include Eisai, a family-owned pharmaceutical company that has developed Leqembi, a breakthrough Alzheimer’s drug. Another is SoftBank, which owns 90% of Arm Holdings (the chip design company used in 99% of mobile phones) yet trades at a 50% discount to the sum of its parts. Then Recruit Holdings, owner of the Indeed job site that serves 300 million people^^^.
Japan still has plenty of detractors but things are changing and there appears room for further market gains at a time when most parts of the world look fully valued. Those who may not want to invest in a pure Japan strategy might consider the likes of the JOHCM Global Opportunities and the CT Global Extended Alpha funds, which have 10% and 7% in the region respectively^^^^.
*Source: Matthews Asia, 12 June 2025
**Source: Hennessy Funds, data at 31 March 2025
***Source: M&G, 16 May 2025
****Source: Lazard, 2 June 2025
^Source: FE Analytics, total returns in pounds sterling for MSCI Japan Value and MSCI Japan Growth indexes, 9 July 2021 to 9 July 2025
^^ Source: Comgest, 4 February 2025
^^^Source: Baillie Gifford, May 2025
^^^^Source: fund factsheets, 30 June 2025
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
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