10 Questions with "Clayton"
Author of Japanese small-cap research platform Kenkyo Investing. Estimated reading time: 11 minutes.
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Today, I’m interviewing Clayton from Kenkyo Investing.
1. Welcome, Clayton! Could you start by introducing yourself: what is your background, and what are you focusing on right now?
Thanks for having me, Michael! I’m Clay, the guy behind Kenkyo Investing, a website focused on small-cap value investing in Japan.
As for my background, I grew up in Okinawa, Japan, studied and worked in Texas, and now live in the Philippines.
Aside from managing my own investments, my career before starting Kenkyo Investing had little to do with finance. In fact, I worked mostly in operations, first as a supply chain analyst in the corporate world in Dallas, then as a construction manager for a family-owned steel company in San Antonio, and then as an operations manager for a small seafood factory in Bacolod City in the Philippines.
Part of the reason I switched from corporate America to small business was to get away from the corporate politics and structures.
Ever since then, my goal was to become a small business owner and work on my own terms. So I worked for one to learn the ropes and eventually decided to start my own.
This is how I ended up starting Kenkyo Investing in 2016.
The small-cap focus and bottom-up approach were a result of my experience in operations. Analyzing mega-caps gets me dizzy, but I can almost visualize the day-to-day operations of many of the smaller listed companies. This is why a vast majority of the Kenkyo Investing reports you see are on small caps.
Aside from preparing these reports, building Kenkyo Investing has led to many interesting opportunities from consulting for funds and providing financial translation services. But the more time I spend preparing the reports, the more I realize how small of a dent I’ve made in uncovering Japan. While there are over 3,800 companies listed in Japan, Kenkyo Investing has covered just over 160 companies in the last 6 years.
To make a bigger dent, I am now focused on figuring out how to cleanly mass-translate Japanese filings.
So far, this has involved a lot of trial and error, with extra emphasis on error.
In any case, over the long term, I’d like to make the translations available to the English world and am eager to see what sort of investment opportunities overseas investors can uncover.
2. How do you think investors should approach the analysis of Japanese stocks? What does a perfect Japanese stock look like, in your view?
On a deeper level, investors should approach Japanese stocks much like any other market.
But on a practical level, this does not mean analyzing Japanese companies in exactly the same way you would an American company. If you stay true to the belief that stocks represent partial ownership in a real company, investing in a Japanese stock makes you a partial owner of a real company operating in Japan.
To this extent, having a basic understanding of Japanese business culture in contrast to your own culture is useful.
And I’m not talking about learning how to properly give and receive a business card or figuring out the appropriate place to sit in a meeting, but rather the higher-level cultural tendencies. For example, the Japanese are generally less confrontational, have a more careful or slower decision-making process, and don’t have a shareholder-centred view when compared to Americans.
A good place to start would be the Ito Review.
This report highlights many of the issues you’ll see in Japanese management teams, and drills down into the historical context of why things turned out the way they are now. It also served as the foundation for Japan’s Stewardship Code.
Now, if Japan is a small part of your global portfolio and you’re looking for a quick filter, just work out a model like you usually would for an equivalent American or European company, then take your usual investment timeline and double it to see if it still meets your hurdle rate.
As for what a perfect Japanese stock would look like, my personal preference is slow growth, no surprises, and an attractive price. The book Tree-Ring Management by Hiroshi Tsukakoshi captures this well.
3. What research tools do you think are helpful for Japanese equities?
The Japan Exchange Group website.
This is a treasure trove of information on the Japanese market. And their English Company Announcements Service gives you all the company disclosures that are available in English.
If you’re feeling extra nerdy, get the Google Translate add-on for your favourite browser and head on over to Buffett-code.com.
When you Google Translate the page and enter a ticker, it’ll take you to the company page with various valuation metrics and past performance data. Scroll down a bit and you’ll see a section that says “Company details” (会社の詳細).
This is information straight from the most recent annual filing. Although it doesn’t contain the entire annual filing, the translations will come out a lot cleaner than when you download the Japanese PDF file and feed it to Google Translate.
4. You have had plenty of experience investing in Japanese small caps. What are the biggest lessons that you’ve learnt so far?
Perhaps this is not the highest impact lesson, but what I’ve learned is that things often take time to materialize in small-cap Japan.
To mitigate this, I strongly prefer to see a soft catalyst. And by this, I basically mean long-term strength in the operating business.
Even for net-nets and deep value investments, which are often seen as a defensive measure because of their strong balance sheets and low valuations, it is difficult to build an attractive investment case without a solid operating business.
5. The Japanese economy has been sluggish. So where can investors find growth? How would you go about finding a growth stock?
Sifting through the companies listed on the Growth section of the Tokyo Stock Exchange is a good place to start.
Most investors would probably be surprised to find out that there are many early-stage startup companies listed in Japan. Of course, some of these companies trade at lofty valuations and don’t have information available in English, so tread carefully!
With that said, if you take the extra step to Google Translate filings and find a story you like, you can cross-check this by taking a look at the foreign share ownership ratio. These are found in the annual filings available through EDINET, and you can use this to get a feel for how well-known the story is.
As a general reference, foreign shareholders account for about 30% of the Tokyo Stock Exchange. I get more excited when I find an interesting company with strong fundamentals and low valuations that has less than 5% foreign ownership.
6. Japanese companies are famous for hoarding cash. Sometimes they seem to care more about their employees than shareholders. How do you deal with the problem of occasionally poor corporate governance in Japan?
Japan undoubtedly has some companies with poor governance.
But I don’t necessarily believe that holding large amounts of cash or caring more about employees than shareholders is always a bad thing. If you’re a foreigner walking into the Japanese equity market, it’s important to keep an open mind, since things are viewed quite differently from the west.
If it’s any consolation, Japan has some of the oldest companies on the planet. And this suggests that there may be a few things we can all learn from Japanese-style governance despite its problems.
With all that said, dealing with governance in Japan is about adjusting expectations.
When reading about corporate governance in Japan, you’ve probably come across answers that point to Japanese managers being more risk-averse or caring more about other stakeholders. And this isn’t wrong, but I think it’s important to know why.
Corporate governance ultimately boils down to one question: Who do business managers answer to?
Historically, Japanese managers have answered to banks. This is because banks were the main source of capital during the postwar “economic miracle” in Japan. As such, Japanese managers have a long-established habit of paying closer attention to credit assessments to keep the bankers happy.
This is why so many Japanese companies have enormous piles of cash.
Shareholder interests have been an afterthought for some time. In fact, “double standard” management, where management teams present shareholders with one set of performance metrics while operating on another internally, was not uncommon.
Over the last few decades, however, corporate balance sheets have improved and share ownership by banks has fallen while ownership by foreigners and trust banks rose. Naturally, you would think Japanese managers now answer more to shareholders. But in reality, change takes time.
The good news is that the push for change has already kicked off.
Shortly after “Abenomics” started in 2012, the Stewardship Code and the Corporate Governance Code were introduced. The first is aimed at encouraging investors to engage with companies and the second is aimed at encouraging companies to listen to shareholders.
Do Japanese companies care about shareholders now?
The results are mixed. But with activist investors taking on highly public campaigns, you better bet companies are at least paying attention. For example, activist firm Oasis Management recently took its gloves off and exposed problematic related-party transactions at Fujitec (TSE: 6416).
So how should investors deal with poor corporate governance in Japan?
To keep it simple, if you’re an individual investor, extend your investment timeline and let the institutional investors do the heavy lifting. For institutional investors, extend your investment timeline and start picking fights… in a constructive manner.
7. Are there any Japanese small caps you think are under-appreciated by the broader investment community?
Yes. Screen for strong fundamentals, low valuations, and low foreign ownership, and you’ll have a pretty big list of Japanese small caps that are under-appreciated by the broader investment community.
To add to this, I think this question ties back into the earlier question about where to find growth in Japan. And if I’m being completely honest, researching startup companies and new technologies is not my strong suit.
What gets me more excited is when I come across healthy companies in sectors with negative sentiment.
One example is childcare. Practically everything you read about Japanese macro says something about low birth rates and ageing population. But would you have guessed that there is a listed childcare company with a multi-decade history of growth?
Youji Corporation (TSE: 2152), which offers children’s physical education programs, had grown revenues for 47 consecutive years until the pandemic struck. The company was heavily affected by the pandemic but is now almost fully recovered.
Then we also have a company taking care of plants boasting a 10-year revenue CAGR of 14%: Universal Engeisha (TSE: 6061), which rents out and manages plants for hotels, offices, commercial facilities, shopping centres, and other commercial facilities, has also managed to grow operating profit at a 12.5% CAGR over 10 years. You would think most manpower-heavy companies are struggling with Japan’s labour shortage, but apparently, some are doing just fine.
Finally, we have Fujisan Magazine Service (TSE: 3138), which provides magazine subscription sales support for both paper and electronic magazines through its online platform. This company is led by the co-founder of Amazon Japan and addresses some of the idiosyncratic structural issues in the Japanese publishing industry.
8. Gun to your head - if you had to put all of your family's savings into a single Japanese stock for five years, which one would it be and why?
Mitsui & Co., Ltd. (TSE: 8031), or any of the major trading companies.
These companies have been around for multiple generations, are involved in pretty much everything, and won’t be disappearing any time soon.
The only reason I prefer Mitsui over the others is that I interned at their US subsidiary as a college student and my boss was awesome.
9. Are there any other investors in Japan that you admire and that you recommend us to pay attention to?
Definitely follow Julien Faure, who manages the Sextant Asie fund over at Amiral Gestion.
Julien is a friend of mine and I’m probably biased here, but he has uncovered numerous high-quality names. I highly recommend going through his fund’s annual report to get some ideas.
One of my favourites is Business Brain Showa-Ota (TSE: 9658), a system developer with accounting expertise that also provides BPO services. Another is Pro-ship (TSE: 3763), the developer of Japan’s leading accounting software package specializing in fixed asset management.
As for fund managers that I don’t personally know, I follow Joe Bauernfreund, who manages the Japan Opportunity Trust for Asset Value Investors.
Their engagement with security services company Secom Joshinetsu (TSE: 4342; now unlisted) led to a healthy exit through a buyout by the parent and Japan’s largest security services company Secom (TSE: 9735).
Another company they are engaging with is global flavour and fragrance producer T. Hasegawa (TSE: 4958), which holds world-class technology but has struggled to leverage it to grow sales. I believe you recently covered this company as well.
10. Where can readers go to learn more about Kenkyo Investing?
Sign up for a free account and browse around at www.kenkyoinvesting.com. The newest reports are available for free. And be sure to stick around, we’re hoping to provide machine-translated filings before long. You can also find me on Twitter where I use the handle @kenkyoinvesting.
Thank you for reading!
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Great interview here, learned a lot!