KonichiValue Japan

Everyone who has read my newsletter know that I have a weak spot for Nintendo. In fact, I made a video and article (HERE) on why I think the company is undervalued over the long-term:

That analysis was about my hopes for the a future path for Nintendo. A path where they manage to pivot away from their dependency on gaming consoles to focus on merchandise and theme-parks as a new revenue stream.

However, the company is definitely not there yet. In fact, almost 95% of their revenue comes from their console and their video games sales. This is why I have decided to do an analysis on its present standing:

So, HERE WE GO!

TL;DR

* Nintendo is a power-house! Almost all of us have found memories of the company either playing Zelda on Game boy under the sheets after bed-time, or watching grandma smashing a serve in Wii Sports.

* Partly due to increased sales during Covid-19, Nintendo has become the 11th most valuable company in Japan. Its current main console, the Nintendo Switch, is on its way to become the most sold gaming console in history; beating PS5 & Xbox Series X by a landslide.

* Today’s Nintendo is extremely reliant on sales of their gaming console. About 97% of the company’s sales consist of hardware and software sales surrounding the Nintendo Switch.

* The latest earnings report indicate that Nintendo Switch sales have reached a plateau. To make matters worse, the company’s leadership does not seem have a succession plan to the Switch. Hence, in the short term Nintendo’s revenue will likely go down.

* Long term, I believe that Nintendo will increase their revenue through other segments, most notably merchandise and theme parks, but the company has not shown that they can pivot yet.

* Nintendo is still raking in cash and its balance sheet is incredibly strong, so there are no worries that the company won’t survive a coming recession.

* For me, I would not buy the stock at its current price, but if I had it, I would definitely hold onto it!

* My stock rating: Hold

What is Nintendo?

Almost everyone knows about Nintendo:

It is one of the world's leading game makers that mainly develops, manufactures, and sells game hardware and software.

The present company was registered in 1947, but it was actually founded in Kyoto in 1889. The company originally produced handmade Hanafuda playing cards. After venturing into various lines of business during the 1960s and acquiring the legal status as a public company, Nintendo distributed its first console, the Color TV-Game, in 1977.

The company was listed on the Tokyo Stock Exchange (TSE) in 1983 which has been its home ever since. So called mirror shares (shares that is directly correlated to Nintendo’s share on TSE) can be bought on the US Nasdaq and the German DAX stock market.

The Nintendo Switch is the company’s most sold home console ever even though it only came out in 2017. However, other massive hit consoles from the company include:

* Game Watch

* Famicom/Nintendo Entertainment System

* Game Boy

* Super Nintendo

* Nintendo 64

* Nintendo DS

* Nintendo Wii

Nintendo has also developed some of the world’s most famous games in-house, such as Donkey Kong, Mario, Animal Crossing, Zelda etc.

Present Nintendo revenue streams

The total number of Switch hardware units sold, which is the company’s current main console, is about 108 million units. The company has also sold more than 600 million games for the Switch. This is thoroughly impressive as before the pandemic, by far the highest sales of a Nintendo's home video game consoles was the Nintendo Wii with a 100 million units sold.

However, the rival Sony with its PlayStation 2 is still the best-selling console of all time, with a cumulative total of more than 155 million units sold. Talking more recently, it seems that the sales volume of the PlayStation 4 will land around 110 million units, which the Switch will beat this year.

With these impressive numbers, it might be easy to think that Nintendo Switch has won this generation, but do not discount Sony! Although the latest model of PlayStation, the PlayStation 5, started selling in November two years ago, it is not possible to judge exactly how much momentum it has because it is still very difficult to obtain. However, it will probably chase after Switch sales with a tremendous momentum once available in stores.

Looking at the game industry widely, the market size of "mobile games" has grown rapidly due to the spread of smartphones, and many believe that the demand for so-called home video game consoles has reached a plateau.

The main question is how Nintendo, the king of the video game market, will survive this. So far, they have managed to stay relevant, but the Switch has been out for 5 years now and Nintendo does not seem to have an additional home console in the works…

Nintendo’s business performance

Let's take a look at the changes in business performance. Looking at the recent momentum, it looks like Nintendo has done better each year, but if we zoom out the time-horizon a bit, that is not the case:

Sales growth rate

Looking at the flow so far, overall sales doubled with the release of Nintendo Switch in the fiscal year ending March 2017 and the fiscal year ending March 2018. Since then, sales have continued with double-digit growth.

However,, the record high sales were about 1.8 trillion yen in the fiscal year of 2009. That year was the height of the Nintendo DS series for handheld game consoles. As for home video game consoles, the Nintendo Wii performed well and recorded record high sales.

After that, the number of units sold decreased, and sales gradually settled down due to the flop that was Nintendo Wii U and forced price reductions.

Sales by region and composition

Moving to the present age, looking at the sales composition ratio by region in the nine months until Q3 in the fiscal year ending March 2021

* Japan: 22.4%

* Americas: 41.1%

* Europe: 25.6%

* Others: 10.9%

The United States accounts for about 40% of sales, and Nintendo is one of the few Japanese companies that still is world leading in the software and hardware space abroad.

As for the composition of the sales: about 1,361 billion yen (about 97% of sales) consists of game-only hardware and software (almost entirely connected to the Nintendo Switch). In these sales, 55.6% of is revenue from the hardware, so about 750 billion yen. Nintendo doesn’t break out software sales, but its safe to assume that software and accessories occupy the remaining 600 billion yen.

The profitability of Nintendo

Next, let’s look at profits:

The movement of the company’s profits is almost 1-to-1 with the ups and downs of console sales.As you can see from the graph, it seems like the sales of Switch consoles might have plateaued in 2021, as a record 641 billion JPY was reached, but has now gone down to around 600 billion JPY (Nintendo’s fiscal year ends in March, so 2022 ended in March 2022).Because Nintendo’s sales are greatly influenced by the sales of hardware , the wave of business performance is very volatile, as its stock price below shows:

The middle period of low profits, lets call it ”the sales valley” is usually where new machines are developed. There are characterized with a temporary fall into negative profits.It is undeniable that Corona has boosted Nintendo’s business performance, so as Corona has settled a bit by the end of 2021, the momentum will likely drop during 2022.

For this year, both sales and profits will likely fall below the 2021 levels.

Cash flow trends

As with the recovery of business performance by the Switch, both operating Cash Flow (CF) and Free Cash Flow (FCF) are growing steadily at this point. Since there is almost no capital investment now, Nintendo does not seem to put a lot of money on R&D to develop a new console. This is a strong indication that the operating CF will be partially returned to shareholders as a dividend and share buybacks.However, unlike US companies, Japanese companies tend to fluctuate their dividend according to business performance, so I think it is not recommended to hold the stock for the purpose of obtaining stable dividends.Nintendo’s ratio of capital investment to cash flow is low. This is because the company is "fabless"company in terms of manufacturing. This means that it designs and sells the hardware but does not manufacture the silicon wafers, or chips, used in its products. *Nintendo is shy about this fact, but acknowledges this in their CSR-reports.

Interesting stock performance indicatior

The performance and stock prices of Nintendo’s main console manufacturers, "MegaChips" and "Hosiden", tend to move in line with Nintendo's movements.That is to say, the performance of these business partners are often a leading indicator on Nintendo’s future hardware sales, so a slump in their stock price is a strong bet that Nintendo’s stock will tank shortly after.

Summary

Looking only at the past 10 years, the stock has performed remarkably well and is constantly rising. However, in reality, it is a company whose business performance and stock price fluctuate in correlation with the life cycle of its main gaming consoles.

This is an huge warning flag presently as Nintendo Switch sales are going down.

Nintendo’s leadership has also gone out and said that they are insecure about the follow-up to the Nintendo Switch. As gaming consoles still are their bread and butter, this is a huge warning sign for a downturn in the stock to come…

Hence, in the short term Nintendo’s revenue will likely go down.However, it’s not all doom and gloom. Nintendo is a wonderful company that has survived many downturns before and always come out much stronger. As my previous analysis concluded, I definitely want to hold the stock for the long haul.

I do believe that Nintendo will increase their revenue through other segments, most notably merchandise and theme parks, but as their gaming consoles still drive their profits and the company has not shown that they can pivot, it is a high risk to bet on that this strategy will succeed.

This is to say, if you are risk averse, I would stay away from the Nintendo stock at the moment.

Important to note is that presently, the company is still raking in cash and its balance sheet is incredibly strong, so there are no worries that the company won’t survive a coming recession.

For me, I would not buy the stock at its current price, but if I had it, I would definitely hold onto it!

My stock rating: Hold

In these dark times for stock markets all around the world, I’ve heard more and more people saying things like “Stock X has gone down 70% since November 2021. It’s so cheap you have to buy it!” or “A stock I own has gone down 50%. I need to buy more of it before it goes up again!”

To be honest, when I see a company losing 70% of its stock value, I instinctively want to buy it! I mean, it feels like a bargain because surely, the stock will bounce back in no time…

This phenomenon is often referred to as the Anchoring effect. It’s a psychological flaw in our ancient monkey-brains where we get “anchored” to a price and think that anything deviating from it is either too high or too low. Marketers use this flaw all the time to trick us! How often haven’t you seen things like “Product X 50% off!” and buy it even though you had no intention of doing so before coming to the store.

Buying a chocolate bar that’s 50% off will likely not break you solvency, but with stocks it literary can. The problem with this thinking is that stocks don’t have a “memory” of what they used to cost. There is nothing intrinsic in a stock that says that if it loses half its value, it has more likelihood of going up again.

There is a trick to not fall for this trap

I want to teach you a little mind game I use to not fall for the anchoring effect.

Let’s say you go to your local grocer to buy something you know the price of, an onion for example. You walk in and you see a sign that says “Onions - $100/each”. You know that onions usually cost $0,5 so you’re a bit shocked to say the least.

Naturally, you call on a store clerk to ask if there’s anything special with the onions today, to which she replies “no, we just marked up the price today”.

Would you still buy that onion?

Most likely you’d be shocked an appalled, but realizing there’s nothing you could do, you’d just buy something else and go on about your day.

The next day you go to the same grocer and see a big sign at the entrance saying “Onions 50% off! Only $50/each!”

What a great deal, right? Well, no! It’s a stupid price and you should definitely not buy that onion!

Its easy to understand why buying an onion for $100 or $50 is stupid, but when it comes to stocks, a lot of people seem to throw this thinking out the window.

When a stock goes up 50%, 100%, or even a 1000%, a lot of people think “Wow, the stock goes up so quickly I need to buy it before I miss out!”

Or when the stock loses value, people go “OMG, it’s trading at a discount, I need to buy more!”. What these people forget to think about is what the stock should be worth in the first place, or what its intrinsic value is.

Of course, knowing what you should pay for a stock is harder than for an onion, but if you know a stock well, you know when it’s overpriced or undervalued.

I won’t go into the details on how to calculate the intrinsic value of a company in this post but the key idea is that it should be based on the company’s assets, present profits, and its realistic profit potential in the near future. Naturally, if the company has high realistic growth potential it should be valued higher, but not astronomically high.

Take Tesla for example. The company is truly innovative and its profits are growing rapidly every year. However, even with the stock losing almost 50% if its value since the beginning of this year, its still trading at around 100x its yearly earnings, or a P/E of 100.

Just to get a sense of how ludicrous this price is, you can think of it like this: if Tesla continued to sell as many cars with the same profits as they do today, it would take them a 100 years to buy all their own stocks at this price…

If you know this, I don’t think you’d buy Tesla today, even with the 50% discount from January 2022...

So to sum it up, if you know the intrinsic value of a stock, just like you know the value of an onion, you know what it is worth and when its worth buying.

Stock markets all around the world are collapsing. The world’s largest index, the S&P 500, is down around 23% year-to-date (YTD). Other indexes, like the Sri Lankan ASPI index have fallen almost 40% YTD and the Irish stock exchange (ISEQ) has fallen 24% YTD.

The main Japanese stock index, the Nikkei 225, looks to have been relatively spared with a fall of of 11% YTD.

In reality, the downturn is much worse. As the Japanese Yen has dropped around 30% to the US Dollar during this time-frame. Acknowledging this, you could rightly assume that the Nikkei 225 has fallen more than its US counterparts.

This means that a lot of you have lost a lot of money. However, it also means that a lot of high-quality stocks are on sale right now!

In other words, it’s time to go fishing in the stock-market abyss:

How I find the most undervalued stocks on the Japanese stock market

To find the absolute top quality stocks on the Japanese stock market that are trading at a discount YTD, I am using three value strategies:

1. My tried and true Value Vetting Strategy

I’ve used this strategy many times in the past to syphon out undervalued companies. Simply put, it aims to find cheap stocks that have a relatively high growth. The criteria are as follows:

* A P/E less higher than 6 but lower than 25

* An average Earnings Growth higher than 7% over the past 7 years

* Return on Equity at at least 10%

* A dividend yield higher than 0.5%

* Net debt / Earnings Before interest, Taxes and Depreciation lower than 2

* ALSO ADDED, a minimum of a -10% in valuation year-to-date (YTD). This is to only find the bargain stocks.

2. The Graham Strategy

As explained here, The Graham strategy is based on 7 specified criteria. A company’s score is ranging from 0 to 7 depending on how many of the criteria a company meets in these areas:

* Size - companies too small will have a low survival rate in downturns

* Financial Strength

* Earnings Stability

* Dividend History

* Earnings Growth

* Moderate P/E ratio

* Moderate price for Book Value (BV)

3. The Piotriski F-score

Piotroski’s F-score is named after the Stanford accounting professor Joseph Piotroski and is number between 0 and 9 (9 being the best) which is used to assess the strength of company's financial position.

The score is calculated based on 9 criteria divided into 3 groups. You can read more about how these criteria are calculated here.

Simply put these are the three main groups:

* Profitability (ROE, OCF, ROA)

* Leverage, Liquidity and Source of Funds

* Operating Efficiency

A company gets 1 point for each met criteria. Summing up of all achieved points gives Piotroski’s F-score (a number between 0 and 9).

Please leave a comment if you have any opinion or questions on my filtering strategies:

The 4 Most Undervalued Japanese Stocks Right Now

Only four companies on the Japanese stock market managed to get a full score on all the extremely stringent criteria above (before the recent market downturn, no company got the full score)!

1. Miroku Jyoho Service (-24% YTD)

MIROKU JYOHO SERVICE CO., LTD. has since 1977 targeted a specific market through the company policy of "developing and expanding the finest management systems and know-how for tax accountant and CPA firms and their clients (small/mid-sized companies), while also offering management information services.”

2. Nippon Concept Corp (-23% YTD)

NIPPON CONCEPT CORPORATION is involved in the transportation of liquid cargoes using tank containers, including chemicals, petroleum chemicals, detergent raw materials, ink, fragrances and food materials. The Company mainly provides its services to chemical manufactures and distributors, as well as food companies.

3. Tocalo (-16% YTD)

TOCALO Co., Ltd. mainly develops and provides thermal decomposition (TD) processing, coating processing, plasma transferred arc (PTA) processing, physical vapor deposition (PVD) processing business, with a focus on thermal spray coatings.

The Company operates in two business segments: The Thermal Spray Coatings segment that provides spray processing for semiconductor and parts of flat panel display (FPD) manufacturing equipment, and gas turbines for power generation and batteries for electric power storage. The company also provides various bearings and other parts for industrial machinery, steel rolls and paper-making rolls, as well as chemical plant parts and other equipment parts.

4. Central Automotive Products (-18% YTD)

CENTRAL AUTOMOTIVE PRODUCTS LTD. is mainly engaged in the Automobile-related segment. The Automobile-related segment is involved in the development, sale, import and export of automotive parts, supplies and accessories, as well as the provision of related services. This segment is also engaged in the sale of new and used cars, as well as the warehousing business.

For 10-years of historical data on today’s companies, please download the Excel file here:

As you may know, I have worked hard for a couple of weeks to produce these two articles:

After publishing them, the question I got asked the most was:

“Do you think buying Japanese real estate is a good investment?”

To tell you the truth, I'm actually super torn.

When collecting data for my first article on three reasons for buying real estate in Japan, I was super positive: It's undeniable that the Japanese real estate market is very cheap for such a high income country. The fact that housing prices have grown rapidly in the past years, especially in many major cities and tourist hot-spots, is an even stronger argument that now might be the time to buy.

However, when writing my article on three reasons for not buying real estate in Japan, my positiveness shriveled up quickly. Even though the data still clearly indicate that it’s an undervalued property market, the arguments against investing are still looming large: An aging population, a hot-spot for natural disasters and the Japanese asset bubble from 1992 still stuck in people’s minds. The vivid picture these negative arguments paints are just so strong it doesn’t matter what the data says…

Comparing the Japanese real estate market to stocks, I felt that it could be closely aligned to a tobacco company: These companies produce great cash flow, give out higher-than-average dividends and are very undervalued, but people still do not want to touch it because of the stigma surrounding them.

Of course, Japanese real estate does not give people cancer, for the most part, and hence this stigma can quickly change to “euphoria”, but as of now it’s still hard to recommend Japanese properties outright.

My thoughts on how you should invest in Japanese real estate

Firstly, I think that if you live here and is focused on the return on investment, the best real estate purchase you can do is to buy a property in a tourist hot-spot that you want to use and can rent out during high-seasons.

Sure, monetarily is not as attractive as renting out a place full time, but people are willing to pay a lot of money for a place to stay during Golden Week and other long weekends! This coupled with the indications that as many people want to travel to Japan when restrictions are lifted as in 2019 shows that many cheap properties in tourist spots are potential gold mines.

There is a big but here: the paperwork required to rent out real estate in Japan is gruesome. Since June 15, 2018, regulations called the “Minpaku” Law came into effect, requiring even Airbnb hosts in Japan to register and other administrative procedures. The main rules are that the property must be registered with local government authorities, guest details by way of official ID must be collected by the host, and the property can only be rented out for a maximum of 180 days a year. More detailed rules below:

As a second option, I do believe that if you intend to stay in Japan long-term, buying real estate to live in is also a good investment. People who have ever rented a place in Japan are all too familiar with key-money (a mandatory “gift” to the property owner of around 1-2 months rent), exorbitant cleaning fees and contract update fees (usually 1 month’s extra rent every 2-years the rent contract is updated).

If you buy a property, you still do have to pay initial stamp duty fees, brokerage fees and some recurring taxes, but in the long run it’s a heck of a lot cheaper than the fees connected to renting. Also, even in this high-inflation environment, it’s still fairly easy to get a loan with a very low interest rate. On top of that, property-loans in Japan comes with a so called “home loan tax deduction” that allows you to deduct 1% of your remaining home loan from your income tax each year for up to 10 years.

However, the rents for Japanese properties, even in Tokyo, are relatively cheap. Per square meter, they can look a bit expensive, but I promise you that the Japanese are experts at space allocation and an apartment of let’s say 30 square-meters feels almost twice as big in Japan as for example in the US. Even per square meter, major cities in Japan are often cheaper than their foreign peers. Also, if you rent and an earthquake, tsunami or typhoon wrecks your home, you’re basically scot-free (if you’re not injured of course) and can just move to a new place.

Lastly, investing from abroad might not be a bad option if you have an agent in Japan that you trust that can take care of all the local paperwork, checks and requirements. However, I'd consider just buying land instead, as it is not exposed to the high depreciation of property prices here.

“Is investing in real estate bad for the locals?”

Another question, or rather critique I should say, I got multiple times while publishing these article were that any foreign investment in real estate in Japan would lead to locals being priced out of their own neighborhood.

I do sympathize with this criticism. In many cities around the world, foreign investments drive up the prices to unsustainable levels and price-out many locals who have lived there for decades and often made it to the attractive place that foreigners want to buy. You probably heard of the exodus of creatives from places like San Francisco, Berlin, or even New York. Instead, these places gets filled up with bankers, tech millionaires and sometimes even people who have no intention to let anyone live in their properties, but just buy them to store their money somewhere.

However, I think the impact you have with your real estate investment depends on your intentions. If you buy a property in rural Japan (which thanks to Japan's amazing train network can be as little as 1h from a major city). Even if it's for investment purposes, I think you would do a huge service to the community. Many municipalities are experiencing serious population decline and don't have enough tax revenues to pay for public services. If you live in the property, or even intend to rent it out, you'll pay taxes to the community and bring in more business.

Even investments in major tourist spots or cities can be good for the locals. For example, Chinese and Australian real estate developers have poured in money in many Japanese ski destinations (most notably Niseko) and invested massively in new ski resorts, hotels etc. Sure, it raised prices for the locals, but created many new jobs and other wealth in the process. The Japanese government is actually looking to replicate the success in Niseko in many other parts of the Japan that are suffering from depopulation.

Real estate investments that hurt the locals are the ones that are used as vehicles to park your money in. These investment are often focused on buying properties or land with no intention to utilize it. They create an artificial shortage of land and houses and raise the prices on the rest of the housing stock.

We're seeing a lot of this in cities like Hong Kong, London and New York, and it's one of the biggest reasons to why property prices there are so astronomically high. So far, Japan has been relatively spared from these kinds of investments, but a higher interest in properties here could definitely bring more investors like that here too.

Concluding thoughts

I do believe buying Japanese real estate is a a good investment, especially if you live here and invest in a second home in a tourist hot-spot to rent out during tourist-seasons. However, in the long-term (around 20 years+) I think that the overall structural problem Japan is battling with, most notably the declining birth-rate, will grow so large that it will inevitably depreciate the Japanese housing market.

With that said, it’s impossible to predict what the future holds for any country, let alone Japan, so if you’re looking to invest in Japanese property today, now might be the best time to strike!

For the TLDR on if ITOCHU is a stock you should buy, skip to 16:54.

For people looking at the podcast show notes, click HERE to go to the article.

TL;DR

ITOCHU's financial condition and free cash flow is good, and its business performance is showing long-term growth. In addition, The company’s dividends are increasing yearly, and the dividend yield is approximately 3%.

On the other hand, ITOCHU is arguably the most popular trading company stock, so its stock price is expensive compared to its peers. I think this is justified as it has performed better than its peers historically. However, if the company’s growth cannot be maintained, the price premium may be corrected and the stock price may fall.

All in all, I believe ITOCHU strong historical performance and current investments show that the stock still has room to grow long term. Hence, I believe this stock is the best stock among Japanese trading companies, and a buy on its current price!

What is ITOCHU, and Why is it so Interesting?

ITOCHU is a trading company with the second largest revenue of all companies in Japan!

Simply put, Japanese trading companies are massive conglomerates that own companies from basically every major industry and connect them to hopefully create synergies.

In general, these trading companies have been valued less on the stock market than the sum of their parts because they’re seen as old relics with bloated balance sheets and slow moving management.

However, in August 2020, Warren Buffett and his investment company Berkshire Hathaway bought roughly a 5% stakes in all big Japanese trading companies, Itochu (8001.Japan), Marubeni (8002.Japan), Mitsubishi (8058.Japan), Mitsui & Co. (8031.Japan), and Sumitomo (8053.Japan), the world suddenly opened their eyes to this forgotten segment.

ITOCHU is steadily growing in business performance and has a dividend yield of about 3% , making it suitable for high-dividend stock investment.

On top of that, the company has consistently improved its bottom line with an average revenue growth of 11.9% and an earnings growth of 16.9% over the past 7 years. On top of that, it is still trading at a Price to Earnings ratio (P/E) of 8.2!

In this article, I want to answer these questions:

* How is ITOCHU's business performance and finance?"

* Is ITOCHU’s stock price cheap or expensive?"

My Six Investment Criteria

To find out if ITOCHU is a good investment, I have the following six criteria:

* Is the business growing?

* Is the profit margin high?

* Is the cash flow abundant?

* Is the finances sound?

* Is the stock price cheap?

* Does the company have good attitude towards its shareholders?

1. ITOCHU's Business performance over the long-term is good

The first criterion is if the business is growing.

The long-term results (Revenue and Profits for the year) of ITOCHU since 2013 are as follows (cited by Borsdata) *NOTE: ITOCHU has a broken financial year where Q4 in a year ends in March.

ITOCHU's revenue is spotty in 2013 and 2019 due to changes in accounting standards and the conversion of other companies into consolidated subsidiaries. Actual revenue has not changed abruptly.

Since it is difficult to see changes in business performance when looking at sales, it is better to look at continuous ordinary income.

ITOCHU's profits have continued to increase since 2013, and reached the highest profits in 2019 due to making FamilyMart a consolidated subsidiary.

Ordinary income increased slightly in the fiscal year ended March 2020, when the new corona problem began.

Compared to before the Lehman Shock in 2008, ITOCHU's ordinary income has more than doubled, and ITOCHU's business performance has grown over the long term.

ITOCHU's business performance is relatively stable because the ratio of resource-related businesses is lower than its competitors.

In general, trading companies have a large proportion of resource-related businesses such as crude oil and metals. As a result, the performance of trading companies is easily affected by resource prices, and during the 2015-2016 period when resource prices were sluggish, the performance of other companies in the same industry, such as Mitsubishi Corporation and Mitsui & Co., declined sharply.

However, ITOCHU’s energy segment only accounts for 10% of total revenue (compared to >20% for Mitsubishi and Mitsui & Co). Hence, ITOCHU's business performance is not as affected by resource prices, and it is a relatively stable stock compared to its peers.

2. ITOCHU’s Return On Equity is high at 17%

The second criterion is high profit margins. I believe that the rate of return is a measure of the strength of competitiveness, and the higher the rate of return, the better.

ITOCHU's rate of return is measured in ROE (return on equity) and ROA (return on total assets). Since 2008, they are as follows (cited by Borsdata):

ITOCHU's ordinary profit margin is in the single digit range, which is low. However, ITOCHU's sales have changed significantly due to changes in accounting policies, so it is difficult to refer to them.

On the other hand, looking at ITOCHU's ROE and ROA, they are 16.9% and 4.8%, respectively. For Japanese stocks, Average ROE is about 8% and ROA is about 4-5%.

In summary, ITOCHU's profit margin seems to be average or slightly higher than their peers.

3. ITOCHU's Cash Flow is Stable

The third criterion is the abundance of cash flow. Cash flow is a numerical value that indicates the inflow and outflow of cash, and is important as an index that reflects the actual state of the business.

* Free cash flow is the difference between operating cash flow and investment cash flow (absolute value).

Also, now when interest rates for loans are ticking up faster than they have for 40 years, having an abundance of cash can truly make or break your balance sheet.

The changes in Free Cash Flow (FCF) of ITOCHU are as follows (cited by Borsdata).

There are years when investment cash flow is high, and there are times when free cash flow is negative.

However, since the negative amount of free cash flow is supplemented by the positive amount of financial cash flow, there is no year in which cash and cash equivalents have decreased.

There is no concern about the cash at hand for ITOCHU, and we can see that it is a company with high business continuity.

4. ITOCHU's Finances are Sound

The fourth criterion is financial soundness.

Looking at the balance sheet, you can see the breakdown of assets and liabilities of a company. The balance sheet shows signs of the company that do not appear in data points like sales and profits.

Sales and profits are important, but I think balance sheet cleanliness is a better indicator of the company’s health.

The balance sheet of ITOCHU is as follows (cited by Borsdata):

On top of total equity outstripping current liabilities by a fair amount, ITOCHU's Net Debt in -54%!

This basically means that ITOCHU currently has 54% more cash than debt and they can pay off all their debt and still have more than half their cash left.

All in all, there is basically no risk that ITOCHU will have issues paying off their debt in the near future, even if interest rates on their loans increases substantially.

5. ITOCHU's Stock Price is at a slight Premium

The fifth criterion is the cheapness of the stock.

The stock price chart of ITOCHU is at 3,751 JPY when this article is released.

*Click here for the latest stock price of ITOCHU Corporation

In this section, I am using the following three as indicators to assess the cheapness of stock.

* P/E (Price Earnings Ratio)

* P/B (Price Book-Value Ratio)

P/E and P/B are important stock price indexes for understanding the fair value of a company, but they are just indicators and not answers. However, they do give a quantitative number on the stock’ cheapness.

ITOCHU's Price to Earnings Ratio (P/E) is at average 8, which is very cheap

First, looking at the transition of ITOCHU's P/E, it is as follows:

ITOCHU's P/E temporarily increased to 13,4 in Q4 2021, but has continued to decline since then.

It is said that the average value of P/E is about 15 on the Japanese stock market, so the current P/E of ITOCHU is generally cheap.

However, compared to ITOCHU's past P/E of around 8, 8.7 times is a little higher, but definitely low.

ITOCHU's Price to Book ratio (P/B) is about 1.3x, which is cheap for its growth.

Check the graph above to see ITOCHU’s historical P/B ratio.

A P/B at 1x is simply put the value of dissolving the company; the value of the company that remains if the business is liquidated is used as a floor of how low the stock could go.

A rule of thumb is that the stock price is cheap if P/B is less than 1x. However, stocks with good performances are almost always higher than 1x as a premium to their assets should be granted for their growth. Hence, a “fair” P/B may be 10x or more for high quality growth stocks.

As discussed above, ITOCHU has a higher than average growth in the trading company segment. Hence, a P/B of 1.3x compared to its good growth rate and profits is very cheap.

6. ITOCHU has a Relatively High Dividend Yield

The sixth criterion is if the company has a good attitude towards its shareholders.

The main way to assess this is to look at the companies dividends. There are pros and cons to dividends and some people prefer to promote reinvestments or stock buybacks in the company. However, stocks with dividends and have the advantage that the rate of decline in stock prices is relatively small when the market is hit by a shock. Also, dividends are historically much less likely to be removed than stock buybacks.

Let's take a closer look at ITOCHU's dividends:

ITOCHU's dividend yield is relatively high, but going down?

The changes in the dividend yield of ITOCHU are as follows (cited by Investing.com):

Dividend yields have fallen slightly due to stock prices rising since 2016. However, the dividend yield has been about 3% at average.

The average dividend yield of Japanese stocks is around 2%, so ITOCHU is a relatively high-dividend stock.

ITOCHU is increasing dividends over the long term

The dividend yield of ITOCHU has gone down. However, this is due to the stock’s increase in value. The actual dividend amount have increased yearly (source: Borsdata):

The current dividend payout ratio is about 25%, and there is still plenty of room for dividend increases .* Dividend payout ratio: An index of what percentage of net income after tax was paid as dividends.

This shows that ITOCHU cares for its shareholders and that we can expect further dividend increases if its current business performance continues to be favorable.

Comparison of ITOCHU and its competitors

As competitors of ITOCHU, I compared the performance of Mitsubishi Corporation, Mitsui & Co., and Sumitomo Corporation with various investment indicators.

Due to the recent rally in natural resources, ITOCHU’s competitors have seen a higher increase in their stock prices. If you believe in a further increase in natural resources, they might be a better bet.

Trading company stocks are generally considered to be economically sensitive, so many companies are cheap in terms of Price to Book ratio (P/B).

On the other hand, ITOCHU's P/B is slightly higher than its competitors, giving a sense that its overpriced. However, ITOCHU has the highest Return on Equity and Return on Assets of all its peers, so the higher P/B is justified.

To summarize: ITOCHU outclasses its peers in long-term profitability, but Mitsubishi Corporation, Mitsui & Co., and Sumitomo Corporation are cheaper stocks.

Summary: Is ITOCHU a Stock Worth Buying?

ITOCHU's financial condition and free cash flow is good, and its business performance is showing long-term growth. In addition, The company’s dividends are increasing yearly, and the dividend yield is approximately 3%.

On the other hand, ITOCHU is arguably the most popular trading company stock, so its stock price is expensive compared to its peers. I think this is justified as the company has performed better than its peers historically. However, if the company’s growth cannot be maintained, the price premium may be corrected and the stock price may fall.

All in all, I believe ITOCHU strong historical performance and current investments show that the stock still has room to grow long term. Hence, I believe this stock is the best stock among Japanese trading companies, and a buy on its current price!

Last week, I wrote about three arguments for buying real estate in Japan (click HERE to view it).

I hope you haven’t bought a house in Japan yet, because this week I will go over the top three arguments against buying real estate in Japan:

Arguments Against Buying Real Estate in Japan:

1# Japanese People are Still Afraid to Invest in Real Estate

Housing prices in Tokyo have risen by approximately 5% since 1992, and in almost all other prefectures housing prices are nowhere near the pre-bubble era prices …

At the same time, from 1992 to today, the average property prices in London have increased by 593% (UK Land Registry Data) or 640% in New York City (Data from Zillow & GO Banking Rates).

Simply put, Japanese real estate prices have grown abysmally slow since 1992, especially compared to foreign peers.

If historical data is anything to go by, when you one day decide to sell your little condo in Tokyo many years from now, it might just cover the cost you purchased it for...

The major reason for this is that the trauma the bursting of the asset bubble in 1992 (biggest asset bubble in history mind you) runs so deep in Japan’s collective psyche that real estate is still seen as a risky and unattractive investment.

However, “thanks” to foreign investments, recent trends have pointed to Japanese real estate prices increasing substantially. Prices for newly built real estate, especially in the Tokyo, have risen significantly since 2013. In 2021, the amount of investment by overseas investors reached 1,330 billion JPY, an increase of 30% from the previous year. This is the first time in history the investment amount from foreigners has exceeded 1 trillion JPY.

Again, the rise in Japanese housing prices is reliant on foreign investments pouring into the Japanese real estate market, so any sentiment change on Japanese property from abroad will likely wreak havoc on its property market.

2# Earthquakes, Tsunamis, Typhoons & Volcanos

Although Japan only accounts for 0.28% of the world’s land area and just 1.9% of its population, it is the site of 18.5% of earthquakes with a magnitude of 6 or greater and 7.0% of all active volcanoes. This was the finding of a 2014 white paper on disaster management:

The harsh reality of a nation so prone to earthquakes, tsunamis and volcanoes is that its people don’t see properties as investments.

It’s beaten into the psyche of the Japanese people that properties constantly get razed and rebuilt and therefore the depreciation for buildings are bigger than most other places in the world.

Repairs can usually be made and the Japanese do enjoy some of the world’s best earthquake resistant buildings. However, repairing aged structures is costly. Even the best homes will have damage after a few 8.0 earthquakes.

With that said, land prices are seen as long term investments by Japanese people, but except for major cities, they have also depreciated over time:

3# Population Decline

If there is one thing Japan is famous for, it’s that the country’s population is declining rapidly.

Japan’s population has been declining since 2009. Back then, the population was 128.56 million and is expected to be less than 125 million by the end of 2022. The population is expected to fall below 100 million by 2058, and if the trend continues, the population will continue to decrease to just above 50 million by 2100.

I won’t go into the details on why this is happening, but the main cause is the rapidly decreasing number of births, which is currently at the lowest it has been since data started being collected in 1899. In 2021, only 811,000 babies were born in Japan – 29,500 less than the number from 2020. The fertility rate in Japan is 1.4 births per woman, far below the population replacement of 2.1.

This is bad for real estate pricing, especially considering that at average, a 1% decrease in population has a 5% decrease in property prices (Hashimoto et al., 2020).

However, major cities and popular tourist destinations in Japan are experiencing rapid population growth as people from rural areas are migrating for better opportunities.

The figure below (figure 7) shows the growth rate of house prices by prefecture using different time periods. The map on the left shows cumulative price changes between 2002 and 2018. It shows that compared to the level of house prices in 2002, all prefectures, except for Tokyo, experienced a decline in house prices (from -5 to -15%).

By contrast, the map on the right shows cumulative house price changes since 2014 by prefecture. Compared to the map on the left, numerous prefectures experienced house price appreciations in recent years, an average 1.9 % nationwide since 2013. The magnitude of price change, however, varies greatly across prefectures: greatest gains seen in Miyagi, Fukushima by 18 % (due to the low base effects related to the earthquake), Tokyo (16 %) while losses have been recorded in Akita (-6.5 %), Shimane (-5.5 %) and Yamanashi (-4.8 %).

In general, house prices in large cities and tourist destinations exhibited major price appreciations, especially led by constructions of condominiums.

In fact, despite the declining population since 2009, the total number of households in Japan continues to increase.

This is due to the share of “three generation” type families declining dramatically as younger people move into major cities, whereas the sum of one-person and couple-only increased to exceed 50%. Less people living together = more demand for property!

However, if the population continues to decline at its current rate, the influx of people to bigger cities will subside over time, and then the real estate prices will likely decline. In fact, the demand for one-person and couple-only houses is projected to subside as early as 2030 (Hashimoto et al., 2020).

So in the short- to medium term (10 to 20 years), property prices in major cities will likely go up with the population influx, but eventually, if the population decreases at the same rate, the influx will stop and they will also fall…

In Summary

Japan’s real estate market is gloomy to say the least:

The Japanese population still do not see real estate as the same low risk, high reward asset as the rest of the world does, and who can blame them.

Traumatized by the bust of the world’s biggest asset bubble in 1992 and a constant barrage of tsunamis, earthquakes and volcanos, they have every reason to doubt the appreciation of the Japanese housing market.

And if that wasn’t enough, the Japanese population is shrinking rapidly and by the end of this century, it will likely go down from today’s 125 million to just above 50 million by 2100.

However, there are glimmers of hope even on the negative side. The population decline has increased the influx on people to major cities which are fueling their property prices. Also, many foreigners are pouring in money in the Japanese real estate market, especially major cities and hot tourist spots.

At the end of the day, if the negative sentiment among Japanese people continues, while its population slowly declines, Japan’s real estate prices will likely decline with them…

NOTE

Before , you should definitely check out my article on why investing in real estate in Japan might actually be a great idea, HERE.

Also, If you are interested in the evolution of real estate prices in Japan, I highly encourage you to read the International Monetary Fund (IMF) working paper “Demographics and the Housing Market - Japan's Disappearing Cities” from 2020 uploaded here:

The paper dives deeply into the issues and possibilities of the Japanese housing market.

Housing prices in Tokyo have risen by approximately 5% since 1992, and in almost all other areas in Japan, housing prices have fallen…

The graph below shows the development of second-hand apartments in Tokyo since the Japanese asset price bubble burst in 1992:

This graph becomes especially abysmal when compared to other countries:

From 1992 to today, the average property prices in London have increased by 593% (UK Land Registry Data) or 640% in New York City (Data from Zillow & GO Banking Rates).

However, this may all be about to change…

Foreigners are going crazy for Japanese real estate!

In 2021, the amount of investment by overseas investors reached 1,330 billion JPY, an increase of 30% from the previous year. This is the first time in history the investment amount from foreigners has exceeded 1 trillion JPY.

Have foreigners gone crazy, or is the Japanese real estate market becoming a good investment?

In this 2-part series , I will help you decide if you should invest in the Japanese real estate market by giving you:

* Part-1: Three Arguments for Buying Real Estate in Japan”, and

* Part 2: Three arguments against buying Real-Estate in Japan

Arguments For Buying Real Estate in Japan:

#1 Real Estate in Japan is Dirt Cheap!

First of all, the Japanese Yen (JPY) has dropped approximately 30% to the US Dollar in less than half a year! That basically gives most foreigners with stable currencies a 20-30% discount on Japanese properties.

Secondly, real estate in Japan have been comparatively cheap for a long time:

Below is a list of the average price per square-meter in the 15 most expensive prefectures in Japan:

Compared this to the 16 most expensive cities in Europe:

Average cost of an apartment in Europe in the 1st quarter 2021, by city (in euros, per square-meter):

As you can see from the two tables, only Tokyo has square-meter prices that can even measure themselves with the 15 most expensive cities in Europe. And housing prices in Tokyo are barely more expensive than Hamburg!

2# Investment Yields in Japan are Surprisingly Strong

First, I made a crash-course in real estate yields that you should check out HERE before reading this section.

In summary, real estate yield is a measurement of future income on an investment based on how much you paid for it. There are two types of yield, Gross yield and net yield.

Gross Yield = annual rent income ÷ property purchase price

Net Yield = annual rent income ÷ (property purchase price + costs at the time of purchase + annual cost)

Since net yield gives us a much better estimate of how much yield you’ll actually get from your real estate investment, it is what this article will use.

How do Japanese real estate yields hold up against other countries?

Well, pretty good it turns out.

In fact, historical investment yield in Japan’s major cities are much stronger than many other “real estate heavens” :

This means that if you buy an apartment in Fukuoka for JPY 10,000,000 ($78,079) and sell it after 10 years for the same amount, you would still make JPY 6,288,946.27 in pure profits (requires you to reinvest your yield in new properties)

For reference, take one of the hottest real estate markets in Europe, the United Kingdom:

Japan looks even more attractive compared to its neighbors.

If you take the only two places foreigners can practically invest real estate in Asia, Hong Kong & Singapore, their net yields are:

* Hong Kong: 2.3%

* Singapore: 3.3%

*Source: Global Property Guide (2021)

In summary, the Japanese real estate market is extremely attractive in Asia. Even in most of Europe and the US, which traditionally have had the most attractive real estate yields, Japan is definitely a contender.

3# Foreigners can own Properties in Japan

Japan not only allows foreigners to buy properties, they also permit land ownership.

In fact, you’ll have the same rights as Japanese citizens when it comes to owning any type of real estate, whether it’s a mansion in Tokyo or an apartment in Okinawa.

That’s a rare attribute in Asian markets. Most countries in the region only let foreigners buy condo units. In fact, many Asian countries won’t let you own real estate at all.

China and Vietnam, for example, don’t allow anything more than a long-term lease on any kind of property. Even Thailand, a very hot property market for foreigners, only allow them to hold apartments if the contract is held by a Thai citizen.

Hence, Japan is one of the safest and easiest countries in Asia to buy real estate as a foreigner. There’s practically zero distinction between foreigners and Japanese citizens when it comes to owning any type of property.

Disclaimer: Owning property or land in Japan does not give foreigners any visa benefits. To be able to live in your property full-time, you still need a work- or spouse visa.

In Summary

As this article has shown you, Japanese real estate is dirt cheap, investment yields are comparatively high and most importantly, foreigners are allowed to own both properties and land.

Since the Japanese asset bubble burst in 1992, property prices have not recovered which has resulted in its real estate market being overlooked by investors for decades.

However, foreigners are finally waking up to this overlooked market. As foreign real estate investments in Japan have exceeded 1 trillion JPY for the first time in history, now is probably a good time to step in!

With that said, there are many downsides with investing in real estate in Japan, but more on that in Part 2: Three arguments against buying Real-Estate in Japan.

For anyone who is considering buying a property, you will surely be interested in what return the property will give you – in other words, the property’s yield. In this article I'll go through why yield is so important to understand, and how to calculate it.

First, what is yield?

A real estate yield is a measurement of future income on an investment based on how much you paid for it.

There are two types of yields: "Gross Yield" and "Net Yield (also called real yield)".

Because property-sites love to make their houses look like more amazing investments than they are, they mostly show the properties’ gross yield.

The gross yield can be calculated by the following formula:

Gross Yield = annual rent income ÷ property purchase price

A gross rental yield is the income on an investment prior to expenses being deducted.

However, the gross yield does not include brokerage fees, property taxes, repair costs, etc. at the time of property purchase.

Here’s where the net yield comes in. As it is calculated by including initial- and operational costs, it is a much better yield estimate than the gross yield.

Net Yield = annual rent income ÷ (property purchase price + costs at the time of purchase + annual cost)

When looking at real estate investment, it is important to always calculate its potential net yield rather than its gross yield.

However, it is not good to look for properties by solely focusing on high yields. Properties with the highest yields are almost always in in rural areas because property prices are much lower, so yields become substantially higher (remember: yields are calculated by annual rent income ÷ property purchase price).

Therefore, in urban areas, even if the yields are lower, properties are less likely to become vacant, and as a result it is easier to obtain a stable rent income.

Lastly, let’s not forget asset value appreciation. If you decide to sell your lovely property, you’ll very likely be able to do so with an increased value in attractive locations. In rural area, you might lose money on the sale or not be able to sell your property at all…

What Net Yields can you expect in Japan?

Below are the expected net yields of studio condominiums and family-friendly condominiums in major cities across the country:

* Source: 45th Real Estate Investor Survey* October 2021 Survey

This means that if you buy an apartment in Fukuoka for JPY 10,000,000 ($78,079) and sell it after 10 years for the same amount, you would still make JPY 6,288,946 in pure profits!

Now that you have learned the importance of Net Yields in relation to real estate investments, we can take a closer look at the insanely attractive Japanese property market…in next week’s article!

Sankyo Frontier is such a rare thing as a modular unit construction company.

These modular units are completely recyclable, takes less than half the time to construct compared to prefabricated houses, and can be stacked on top of each other like Lego blocks to build anything from a pop-up shop to a 10-story housing block!

You might think it’s some kind of Silicon Valley startup with a billion-dollar valuation and no profits to be seen.

However, the truth of the matter is that the company has been around since 1969, is only valued at around $500 million with a P/e of 9(!), and is actually making money, and lots of it!

Find out why in my latest podcast episode: “Sankyo Frontier: The Most Interesting Company You Never Heard About”