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Stocks

Japan Inc. needs to go on offensive to keep rally going

TOKYO -- While the Nikkei Stock Average has finally bounced back to 20,000, sustaining the bull market will require some changes at Japanese companies.

     In his 34 years working in the Japanese market, Andrew Rose at U.K. asset management company Schroders has watched the benchmark index rise from around 7,000 to just over 20,000 now, with the 1989 peak and ensuing slump in between. This time, he says, real change could happen.

     Companies need to improve their profitability -- an area where they pale in comparison to their U.S. and European counterparts -- and their management to win the favor of global investors. Listed Japanese companies have an average net profit margin of 3%, compared with just over 8% in the U.S., resulting in lower return on equity.

     Although the Nikkei average has returned to 20,000, 40% of companies still have stock prices below their theoretical liquidation value per share, which is less than book value per share. Some companies are taking steps toward reform, but more than a few have been slow to get moving. There is still considerable room for corporations to revamp unprofitable businesses.

     Companies also need to use the nearly 100 trillion yen ($828 billion) in cash they hoarded under the timid mindset of the deflation years. The service sector, including the retail and restaurant industries, must follow the lead of the automotive and electronics industries in putting money toward wage hikes, investment and shareholder returns.

     There is data indicating that excessive corporate savings can hurt gross domestic product. Acquisitions and capital spending encourage profit growth. And corporate spending has positive effects for the broader economy, since higher wages stimulate consumer spending and investment bolsters demand for production goods. Circulating funds through the economy is one of the major functions of companies.

     The government has included dialogue with investors in its growth strategy in hopes of encouraging these changes. Some argue that this represents a significant step forward for Japan, which has been far behind when it comes to corporate governance. Major life insurance companies, among others, have started to keep a closer eye on management at the businesses they invest in.

     If more companies take action, the Nikkei average can go beyond 20,000, Rose says. Corporate Japan will need to make steady progress to ensure that the current rally does not end up being just a bubble fueled by monetary easing.

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