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Japan-Update

Better investor return crucial for Nikkei's further advance

P/E ratio creates upper resistance as earnings growth slows

Nippon Paint closed 8% higher Monday upon news of a shareholder's challenge from the Wuthelam group.

TOKYO -- As earnings growth is largely expected to slow, the Nikkei Stock Average is unlikely to climb much further unless investors are convinced that further increases in forward price-earnings ratios are justified. The key to winning their support lies in better corporate governance and investor return.

The Nikkei index inched up just 8 points Monday to close at 23,816, once again falling just short of the 24,000-point threshold.

A palpable desire to gauge the impact of the U.S. government shutdown swept over Tokyo that day. But Nippon Paint Holdings and textile maker Teikoku Sen-i rose above the malaise, gaining more than 8% and 4%, respectively. Both were subject to shareholder proposals, reported late last week.

At Nippon Paint, principal shareholder Wuthelam wants to appoint additional directors to the Japanese company's board. The aim is to maximize corporate value, the Singaporean coating group said.

That proposal should be embraced when considering the growth in medium- to long-term corporate value, said a fund manager working at an international asset management firm that owns Nippon Paint shares. This view indicates that Nippon Paint will face further pressure from shareholders.

Listed Japanese corporations are expected to boost pretax profit by 11.6% in fiscal 2017, according to a study by The Nikkei. But market consensus holds that the metric will shrink to the upper single digits in fiscal 2018.

With corporate earnings on the verge of slowing, the forward price-earnings ratio is likely to become the go-to gauge to predict whether stocks will climb. For the Nikkei average to rise to 28,220 points, the average P/E ratio has to reach 17, according to FIL Investments (Japan).

Average P/E ratios rose to the 50s and 60s during the asset bubble, only to sink after the bubble popped in the early 1990s. The metric recovered to above 20 in 2013, during the advent of the Abenomics rally. But it has since retreated to the 15 range. The Dow Jones Industrial Average sports an average P/E ratio topping 18.

Toyota Motor, Mitsubishi UFJ Financial Group and several other underperforming blue chips bear some responsibility for Japanese stocks' low overall P/E ratio. Those big corporations' P/E ratios, languishing at 11-12, paint a sharp contrast with the 40-plus figures enjoyed by such companies as Nidec and Fast Retailing, both of which have been pursuing brisk profit growth under the stewardship of corporate leaders who are also major shareholders.

Blue chips with low P/E ratios could boost share prices by governing more from the shareholders' perspective. For example, companies could shed stock holdings that don't seem to add value to their portfolios or focus more on lifting profitability.

SG Holdings, the parent company of parcel deliverer Sagawa Express, has rocketed 27% since its blockbuster initial public offering last month. Its P/E ratio has also jumped from the 18 range to 23-plus, topping the transport industry average of less than 17. A big reason for this divergence is SG Holdings' pursuit of profitability.

Hideto Fujino, president of Rheos Capital Works, approves of the way SG Holdings walked away from its contract with U.S. e-commerce giant Amazon.com. SG "takes a solid approach toward earnings compared with the likes of Yamato Holdings, which increased business with Amazon.com despite low profit margins," said Fujino.

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