Why Warren Buffett has bet on “bad” strategy in Japan’s comeback

Despite this, Japan’s top-tier firms remain undervalued. The price-to-book ratios, which measure the market value relative to its book value, of roughly half the companies listed in the top tier of the Tokyo Stock Exchange hover around or even below 1.0. This means Japan’s price-to-book ratios are highly attractive for value investors compared to the US and Europe. Less than 40% of Japan’s listed companies have P/B ratios higher than 2; in the US this is more than 75%, and in Europe more than 50%. 

Alongside a fall in the value of the currency and low P/B ratios, a third factor has increased investors’ confidence in the Japanese market. 

Enter the insider activist 

Since April 2023, Hiromi Yamaji, a former Nomura banker who is head of the Japan Exchange Group (JPX), which controls the Tokyo Stock Exchange, has started to shake up the traditional business establishment by vigorously advocating for change and shaming Japan’s corporate leaders for failing to achieve higher valuations for the companies they lead.  

Shame is known as a powerful sanction in Japan where others’ evaluations of their companies’ substandard valuations can cause corporate leaders and their employees to suffer shame. Consequently, a banker suggests that “Yamaji-san is the biggest activist in Tokyo at the moment”. Yamaji’s “shame regime” will launch on 15 January 2024 and is expected to expose the underperformance of companies and their top management. According to the Financial Times, expectations are that during his four-year tenure (which ends in 2027), he might just shame leaders into delivering higher returns even faster. Hardly any development could be more welcome to value investors like Buffett, who likes to buy low and waits for the rise.  

Buffet’s “bad strategy” approach 

With the Bank of Japan laser-focused on reviving Japan’s languishing economy, Buffett understood that interest rates would remain lower for longer than many countries in the West. Using his heft and global renown, Buffett was able to convince Japanese creditors to give him even better rates than the already net zero costs in Japan. By borrowing Yen, Buffett eschewed currency risks. The next step was to find attractive investment opportunities in Japan. 

The traditional value investing playbook would see Buffett investing in the Japanese trading company that offers the highest upside. In this case, however, Buffett decided to invest in five rivals in equal measure. Buffett’s move appears more like a shotgun approach than a strategy. If none of these general trading companies stands out, textbooks suggest, they all have no, or at best “bad” strategies.  

Three logics help explain why Buffett opted for companies with “bad” strategies.  

First, on a micro scale, each of the Japanese general trading companies has a good track record. They are stable and highly profitable, pay high dividends, and increasingly also buy back shares. This makes each of them attractive from a financial perspective, even if their results are strongly correlated.  

Second, logic suggests that diversified portfolio companies invest to maintain their diversified portfolio. When Berkshire Hathaway, a conglomerate, accumulated shares in Japanese conglomerates, it bought what it knows and maintained a high degree of diversification, albeit in one country in a geopolitically critical region. 

The moat of Japan 

Third, for a long time, strategy has sought to find ways to make companies stand out, and value investors have sought to identify individual companies with “moats”. Simply put, like those that surrounded medieval castles to protect turf and treasure, moats give companies a competitive advantage that makes it easier to protect their market share and profitability over time. Examples of modern-day moats include high switching costs, intangible assets, network effects, cost advantage, and efficient scale.