Episode 10.1: Opportunity Hidden in Plain Sight: Tokyo Stock Exchange Developments

• Episode and guest introduction (0:00 – 0:22)
• What moves from the Tokyo Stock Exchange focusing on improving governance standards mean for value investors (0:23 – 2:07)
• How price-to-book valuation matters when assessing Japan’s corporate health (2:08 – 3:49)
• Disclosures (3:50 – 5:30)

Alex Warren: Welcome to the Power of Patience. I’m Alex Warren, product specialist at Aristotle Capital. I’m speaking with Aylon Ben-Shlomo Client Portfolio Manager at Aristotle Capital. We’re going to be changing up the format today to talk about Japan, and this episode is titled Opportunity Hidden in Plain Sight. Aylon, thank you so much for joining me today.

Aylon Ben-Shlomo: Thanks for having me, Alex. And thanks to all the listeners out there.

Alex Warren: Now, Aylon, I want to get your thoughts on some of the news the last year. What do the moves from the Tokyo Stock Exchange focusing on improving governance standards mean for value investors?

Aylon Ben-Shlomo: The recent announcements from the Tokyo Stock Exchange are using some rather harsh language. They’re focused on promoting measures that increase “the literacy of cost of capital and stock price”. They’re zeroing in on companies that persistently trade at a price-to-book ratio of below one, meaning they’re focused on companies that are less efficient with their capital and therefore not generating a substantial returns for their shareholders. And while these all sound like very good initiatives to us, perhaps they sound more like something that an activist investor would bring to the table rather than a stock exchange. The media is calling these initiatives, naming and shaming companies that are named by the Tokyo Stock Exchange as being on this list run the risk of being delisted. While they don’t face regulatory or legal challenges, fines and the like, they do run the risk of being delisted, which would obviously make cost of capital more expensive. And being delisted is not something any publicly traded company wants. There is clear accountability in the public spotlight that is being created by these initiatives. So what are companies doing? Cash balances are declining, dividends are increasing, buybacks are increasing. Corporate Japan has gotten the message, or at least they’re receiving the message and they’re acting on it by improving returns to shareholders, improving profitability, improving margins, and of course, there is still lots of room to go, but we’re encouraged by what we’re seeing and we’re eager to monitor the progress.

Alex Warren: Now, Aylon, you touched on this a moment ago, but I want to dive in a bit deeper. How much do you believe price-to-book valuation matters when assessing Japan’s corporate health?

Aylon Ben-Shlomo: While price-to-book is clearly something that the Tokyo Stock Exchange is focused on, and we would agree that it can be a helpful valuation metric, it is not our North Star hereat Aristotle Capital. What we’re focused on is cashflow return on economic value. It’s our way of getting at free cashflow yield or owner’s earnings. What can a business generate in terms of cash for its shareholders? That’s what ultimately drives intrinsic value in our eyes, and that’s what we’re most focused on. And so we put more emphasis on that than price-to-book. But we’re also mindful that price-to-book right now in Japan, at least in the Tokyo Stock Exchange’s eye, that’s going to be a metric that they’re going to hold companies accountable for. And so we’ll be aware of it, but it won’t drive our decisions. What will drive our decisions here at Aristotle is cashflow, cashflow, return on economic value, what we call C-F-R-O-E-V of C-F-R-O-E-V has guided us around the globe.

It’s enabled us to find companies that meet our QVC criteria, not just here in the U.S. but in Europe and in Japan. It’s exposure that we’ve had for a number of years, and it’s a quality that we see in Japan today and in the future. There are lots of cashflow generating businesses that are leaders in their industry across the globe that happen to be headquartered in Japan. Now with the tailwinds of the Tokyo Stock Exchange naming and shaming initiatives, perhaps that will give these companies the extra push and will give investors around the world the extra spotlight that they need to see the opportunities that we’ve seen in Japan for many years.