After 30 low-inflation, low-growth, low-interest rate years, Japanese listed companies are now seeing substantial growth in their earnings. What factors are driving this and what does it mean for investors considering creating or increasing exposure to Japanese equities?
Our analysis of data from the London Stock Exchange Group shows that now the earnings outlook for Japanese listed companies is improving far quicker than for US or European companies.
The revision index – a measure of how often analysts’ earnings forecasts for stocks are upgraded or downgraded – is considerably more positive for Japanese stocks than for US or European stocks. In the first eight months of 2024, there were 3.4 analyst upgrades for every downgrade of Japan’s TOPIX index, 1.1 upgrade for every downgrade for the US’s S&P 500 and 3.6 downgrades for every upgrade in Europe’s Stoxx 600**.
That improved outlook tallies well with projections for earnings growth for Japanese companies this year and next. Consensus projections for earnings per share growth for Japanese companies are +7.8% for 2024 and +9.3% for 2025.
The projected increase in earnings for Japanese companies can be attributed in part to rising wages among Japanese workers being passed through into the economy.
The 2024 Spring wage negotiations with trade union federation Rengo resulted in a wage increase of 5.1%, the highest figure recorded since 1991. This has contributed to real wage growth (wage growth above inflation) almost turning positive despite inflation being relatively high by Japanese standards. Rengo recently stated that it would demand a similar increase in 2025.
These wage increases have benefitted domestically-focused Japanese companies, giving their earnings an opportunity to grow more quickly. With the yen remaining weak, larger export-focused Japanese companies have also been able to continue their earnings growth, creating a positive picture for Japanese corporates. This trend looks set to continue in 2025.
Another contributor to increased earnings for Japanese companies is the Japanese government’s campaign to improve their capital efficiency. This was long mooted as a goal, but recent years have seen the campaign begin to deliver more significant results.
One of the main aims of the campaign is to get Japanese listed companies to increase their use of share buybacks – something that will obviously impact future earnings per share in a positive way. Another key aim is to push more Japanese companies into unwinding their cross-shareholdings in each other, freeing up capital for investment or to return to shareholders in the form of buybacks and dividends.
While there is much improvement still to be made in this regard, larger Japanese companies seem to have taken the message to heart. 2024 is likely to have set a record for the value of share buybacks in a year, while sales of cross-shareholdings are demonstrating a similar trend.
All of the above is giving Japan Inc a boost in earnings, which is translating to an increase in share prices. The TOPIX index has risen 15% in the year to date, even taking into account the unexpected ‘blip’ the market experienced in August.
But there is potential for the picture to improve even further for Japanese companies. We believe that their future earnings growth is still not fully priced-in for Japanese listed companies.
The 12-month forward price to earnings ratio****** for Japanese listed companies currently stands at 13.7x. This is in the mid-range for recent years. However we believe that this does not adequately take into account the increased potential for Japan exiting deflation, which is likely to lead to continued higher earnings growth.
It also does not fully reflect what we believe is a change in corporate mindsets in Japan, in which shareholder returns are treated as a priority for management teams. Capital costs and share prices are now front-of-mind across corporate Japan. It is reasonable to believe that a 12-month forward P/E ratio of 15x is achievable in the foreseeable future as a result.
All of this means that Japanese equities are at an inflection point the likes of which has not been seen for 30 years. For investors considering this market, there is clear potential for continued increased earnings among Japanese companies. The tailwinds of the exit from deflation, wage growth and sharply improved capital efficiency cannot be ignored.
But like many other countries with strong export economies, the election of Donald Trump in the United States brings with it concerns for Japan about the possibility of tariffs on exports to the United States. Indeed, these concerns have been reflected in the ‘wait and see’ attitude of investors since the US election – the TOPIX index has flatlined since then despite the positive picture in Japan.
While the actions of the new US government are hard to predict at this stage, it is much less challenging to see the future path for the Japanese economy and Japanese businesses. Investors should make sure to remember those fundamentals when making decisions.
