Joel Tillinghast on investing in Japan

In the United States, every executive has been instructed that his or her top goal is increasing shareholder value.  When I bring up this idea in Japan, most businessmen (and in Japan, they are men) have no clue what I'm talking about.  Perhaps it's because employing armies of people and having a dominant market share bring more prestige in Japan than high profits.  Some argue that the Japanese are taking the longer view than American corporations.  Eventually, having a strong market share should lead to profits.  On average, though, Japanese companies earn lower returns on equity than other businesses around the globe.  Social ties and responsibilities are conceived differently in Japan.

"The nail that sticks out gets hammered down"; so goes the Japanese proverb.  If making too much money would make them stick out, they won't do it.  CEOs in Japan are paid much smaller multiples of the average employee's pay than CEOs in America.  Employees probably do feel greater loyalty to their company when everyone is more nearly in the same boat.  This might explain why politics is less polarized in Japan.  But today the "salaryman" system of lifetime employment really exists only at larger companies.  Many companies try to prevent being hammered down by holding large cash balances and avoiding debt.

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As an investor, I want profits that will keep sticking out and not be pounded down quickly.  The retail industry is where I've often found the un-Japanese desire to stand out, and these have indeed been stand-out investments for me.  Cosmos Pharmaceutical is a discount drugstore chain on Kyushu, a smaller island on the southwest corner of Japan, far away from Tokyo.  Cosmos offered very sharp prices to consumers by keeping a tight rein on operating costs.  It's selling, general, and administrative (SG&A) expense was just 14 percent of sales, an outstanding number.  Walmart, which also pinches pennies, spends 19 percent of sales on SG&A.

Cosmos was founded in 1983 by its CEO, Masateru Uno, and has grown rapidly.  Perhaps because Cosmos is in a less populated region of Japan, good store locations can be secured more quickly and at a lower cost.  Drugstores earn better profit margins on private label products than on branded products; Cosmos sells a lot of private label.  Cosmos turns its inventory over faster than the leading American drugstores, CVS and Walgreens.  The average life expectancy is four years longer in Japan than in the United States, so the population is aging.  This would seem to set up drugstores for strong growth, but the stock was trading at only ten times earnings in 2011.  Over the next five years, the stock soared sixfold, as growth continued and the P/E expanded.

~ Joel Tillinghast, Big Money Thinks Small (2017), pp. 91-93