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It turns out that Warren Buffett can spot an arbitrage opportunity.
The fact that the famed investor found a trade in the sleepy world of Japanese general trading companies may have earned smirks from jaded market veterans. But Buffett’s timing was good. Other investors shouldn’t try to follow the Oracle of Omaha now.
Long seen as artefacts of the previous century, shares of these groups including Mitsubishi Corporation and Itochu have traded at typical conglomerate discounts. This year, with Japan’s equity market approaching an all-time high, it is Buffett who benefits. Witness Mitsubishi Corporation’s pledge earlier this month to return ¥500 billion ($3.4 billion) to buy back shares, the equivalent of a tenth of its shares. Its shares soared on the news.
Japan’s sogo shosha developed into the country’s commercial core as it opened up for trade in the late 19th century. They are still seen as representing traditional Japan, rather than its future. Buffett’s team saw value and were not choosy. He bought equal stakes of 5 per cent in the big five trading companies, which also include Mitsui & Co, Sumitomo and Marubeni. He has bulked up these positions in the last year.
The trading houses’ shares have since reversed years of so-so performance. Together the group has left the broader market indices far behind, more than doubling the percentage increase of the Topix as an example. However, much of that has come via a fattening earnings multiple. The five traded at about 7 times forward earnings in mid 2020. Today they fetch an average of 12 times.
Perhaps more important, the market values of the five companies back then were around a quarter below their respective net asset values. Today the same group is about 25 per cent above book value. Barring some high profit growth to lift the underlying book value, any hopeful arbitrage opportunity has disappeared.
On current analyst forecasts, only one of these trading houses, Itochu, offers positive earnings per share growth through 2027. Even then, that earnings expansion is only about 4 per cent annually, hardly pacy.
Nevertheless, pressed by Tokyo’s directives on better governance, the attitude of Japan Inc towards its shareholders has changed over the past decade. That may have kept Buffett in these stocks. But the good news is already reflected in the market values of the trading houses.
Investors coming to the sogo shosha now would do better with a Japanese index fund.
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