Summary
Executive summary
Japanese equities traded at a discount
The Japanese equity market has underperformed for many years and has traded at a lower price-to-book (P/B) valuation than global peers. This discount has been warranted because return-on-equity (ROE) has been lower, reflecting an inflated denominator: balance sheets are overly large. Many companies have hoarded excess cash, held sizable stakes in other companies and built significant property portfolios. Those assets are not required for operations and represent poor uses of shareholder capital.
Corporate governance reform tackling Japanâs valuation discount
Over a decade ago, under Prime Minister Shinzo Abe, Japanese regulators pushed a corporate governance agenda to ensure businesses allocated capital more efficiently and acted in shareholdersâ best interests. Since then, many companies have divested non core assets, reduced cash balances and returned excess capital to shareholders. These actions shrink the ROE denominator, lift ROE, support higher P/B multiples and increase earnings per share (EPS) as shares outstanding decline. Nevertheless, Japan Inc. still needs further balance-sheet reform and shareholders should benefit as value is unlocked over the coming years.
Economic backdrop provides additional tailwinds
Furthermore, this process has more recently been playing out against an increasingly favourable economic backdrop. The Japanese economy appears to be emerging from decades of secular deflation. Stronger nominal GDP growth and a more normal interest-rate regime provide a substantially healthier environment for corporate profitability.
Japan disciplined adaptation to a world of controlled disorder
We believe this time is different for Japanese equities. A political reset has enabled a disciplined, large-scale integration of fiscal activism, security, and technology policy. Japan has exited deflation both economically and psychologically, is building capacity rather than imposing austerity, and is repositioning as a strategic anchor in the Indo-Pacific. Social constraints are managed through technology, marking a structuralânot cyclicalâshift.
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