Consumer spending, capital investments and exports will remain the main locomotives of growth. Even though the past decade was a terrible period for Japan, GDP growth in real terms averaged more than 1 per cent per annum. Japan could experience compound annual GDP growth of 2.5-3 per cent per annum but such growth is unlikely. Assuming neutral to positive government policy, 1.5-2 per cent annual compound growth is possible.
Annual compound growth and steadily improving productivity could result in long-term annual earnings growth of 7-10 per cent. There will be good and bad years, however. An encouraging factor is that savings remain high, and most of this money is in banks where it is earning annual returns of less than 1 per cent. A return of investor confidence, which seems apparent, could encourage some of this money to move into the stock market.
However, investors must be selective.
A number of larger stocks have good growth potential and appear relatively cheap and there are some interesting, if risky, recovery plans among the large cap stocks. However, there is more growth potential in the medium-sized and smaller stocks.
A company that has no sales growth can usually improve profit margins to a certain level and no more. We are more interested in companies that can grow sales and earnings over the longer term: where sales are going up, profit margins are improving, free cash flow is positive and management cares about shareholders. The auto parts companies have good long-term sales and earnings growth potential. Many of them can grow faster than the leading auto companies and faster than the industry as a whole due to a revolution in auto parts. These companies demonstrate that rigorous research is what it takes to succeed in Japanese stock picking.
Ed Merner, president, Atlantis Investment Research Corporation, Japan Fund Manager, Atlantis Japan Growth Fund
