Often reduced to the image of a dream vacation spot and to its aging population, Japan has evolved significantly in recent years, and many commonly held beliefs - some more accurate than others - deserve to be revisited.

A high cost of living? Not true, as the famous index can testify, with a local Big Mac menu costing less than €5. An economy in deflation? False. Inflation has been back for more than three years, with a recent rise in the price of rice at the heart of the elections, but above all the return of wage inflation. Some companies have started to increase salaries for new graduates, after a 25-year freeze! Could it be that a new sun is rising over the country?

Unsuspected depth of ratings

If we look at its stock market, Japan has a very rich and deep list of around 4,000 listed companies and is also notable for its proportion of small companies, around two-thirds of them. Being listed remains the Holy Grail for any Japanese entrepreneur. It is easy to find companies where there is an alignment of interests between investors and company directors, who are often majority shareholders. Kabunushi Yutai" also enable a virtuous circle to be created with private individuals, through the distribution of vouchers and gifts to shareholders. Used by a third of listed companies, they help to stimulate and retain individual shareholders, while reminding us that the stock market is not just a means of speculating, but rather of sharing value with a company. In addition, there is a preconceived notion... which is true this time: that the market is structurally reasonably valued, especially for small caps. Historically, this situation has been explained by classic management shortcomings - sometimes too cautious or conservative, leading to under-optimisation of resources and return on capital.

Welcomed reforms

Faced with this problem, the Tokyo Stock Exchange (below photo of their "Kabuto-jinja" shrine in Tokyo) has put in place measures to improve the situation, asking the worst-valued companies to take concrete action. First with recommendations in 2023, then with increased pressure in 2024. This represents a real upheaval in Japanese capitalism, which has long been accustomed to cross-shareholdings between customers and suppliers and the accumulation of excessive cash holdings.

These measures are gradually taking hold, making capital allocation a central topic in the investor presentations of most of the companies we now meet. At the same time, the phenomenon is also supported by the rapid development of activist investors. Whereas in the past, some of them sometimes ended up in prison, they now enjoy a more favourable playing field. More and more companies are launching divestments, share buyback plans, or strengthening their shareholder return policy. All these factors are contributing to the market's gradual recovery.

Microcaps face structural challenges

Beyond valuation issues, many microcaps are turning operational challenges into opportunities, in a multitude of niches:

The ageing of the population is a boon for the M&A advisory sector, with managers reaching an average age of 62, 52% of whom have no natural successor. A niche exploited by M&A Capital Partners.
Japan is also lagging far behind in terms of digitalisation. Despite being at the cutting edge in hardware, its software companies remain virtually absent from the international market, offering a growth boulevard to companies capable of attracting talent, such as SRE, I'LL, System Support, TDC, Techmatrix, Baudroie and many others, to help the country make up this deficit.
Faced with a growing number of natural disasters, Raito Kogyo is relying on the recognition of its landslide protection systems, while TRE is managing waste after the event, as it did recently at Fukushima.
To counter rural desertification, S-Pool has launched supervised agricultural farms to promote the professional integration of people with disabilities. As for Lacto Japan, the leading importer of milk powder, it is taking advantage of the crisis in vocations in the dairy industry, despite rising consumption.
Even in the face of a declining birth rate, IBJ benefits from a system of government aid for its marriage agency service dedicated to Japanese people wishing to marry.

All these structural advantages make Japan an ideal playground for selecting small, differentiating stocks - an area we have been exploiting since 2016 within the Mandarine Global Microcap fund, with more than 400 investor meetings already completed (photo below at one of our local brokers). This region represents 25% of our investment universe, alongside the United States and Europe, and offers genuine diversification within a global equity allocation.

Photos © Mandarine Gestion & tawatchai07 (Freepik)

Japan, the next destination for investors?

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