Is Japan turning shareholder-friendly?

Japanese dividends accelerated in late 2013 and the subsequent 30% growth must have contributed to the 40% gain in share prices

Among popular asset categories, Japanese equities have shone over recent months. In fact, Japanese stocks are up around 10% in yen (luckily we were Overweight). Given the low returns earned by most other assets, is it time to reduce exposure to Japanese equities? We think not.

It is interesting to note that the yield on Japanese stocks has not deteriorated despite the rise in price. In short, Japanese dividends are growing rapidly. Around the time Shinzo Abe was elected as prime-minister (December 2012), Japanese dividends were growing at a low single-digit rate. They then accelerated and by the end of 2013 growth reached double-digits where it remains (the current year-on-year growth rate is around 15%, using Datastream indices). Since the acceleration became evident at end-October 2013, dividends have increased 30%, while the market is up 40% (the dividend yield has fallen from 1.7% to 1.6%). By comparison, over that same period Eurozone dividends have fallen 11% and the stock market is down 2%.

That comparison with the Eurozone is instructive. Eurozone dividend growth bottomed near -20% at around the time Mario Draghi was making his “anything it takes” speech (July 2012) and had turned positive (mid-single-digits) by mid-2013, briefly exceeding that of Japan. However, from there the paths diverged – while Japanese dividend growth advanced to the mid-doubledigit range, that of the Eurozone stabilised for a while before slipping back into negative territory in late 2014 and again touching -20% in early 2015.

Figure 1 shows one obvious difference between the two regions: though profits have recently accelerated and decelerated at the same time in both regions, EPS growth has consistently been higher in Japan since April 2012. That timing roughly coincides with the peaking of the yen versus the euro (the yen peaked in September 2012 and had lost 37% of its value by the time it bottomed in December 2014).

Apart from forcing down the yen via BOJ asset purchases, Abe’s policies may be supporting stocks via a more shareholder-friendly approach. Dividend growth has recently been sustained in the face of lower profit growth by a rebound in the pay-out ratio (the share of corporate earnings paid out as dividends). After bottoming at just above 25% in early 2014, Japan’s pay-out ratio has risen to around 30% (see Figure 2). As the historical average is around 38%, there would appear scope for this trend to continue.

It the weak yen is helping Japan’s economic performance (we think it is), profits will again accelerate. This should help sustain dividend growth, especially if Abe is able to boost pay-outs to above historical norms. We believe the rise in Japanese equities was, and will continue to be, justified by dividend growth.

The bad news for equity investors is that Eurozone dividends have been sustained in the face of falling profits by elevated pay-outs (Figure 2). It is to be hoped the nascent economic recovery continues (profits follow the economic cycle very closely) and that a weakening currency offers the same support to equities in the Eurozone as it did in Japan. Pay-outs will no doubt decline, so that not all of the profit growth will be passed on to investors. We have a positive view on Eurozone stocks but the balance is more delicate than in Japan.

Paul Jackson (Head of Research), András Vig – Source