Japan is Still Cheap Value maven Peter Cundill can invest in any market in the world. He's chosen to put much of his fund's money in Japan
By Jonah Freedman; Peter Cundill

(MONEY Magazine) – Could Japan at last be back? Over the past 12 months, the benchmark Nikkei 225 index has returned 32%, nearly twice as much as U.S. blue chips. And although its market has retreated over the past few weeks (as have stock markets around the world), Japan's economic fundamentals are still improving. Its trade with China is booming, and both corporate profits and consumer spending are getting stronger. The country's gross domestic product grew a surprising 5.6% annualized in the last quarter.

But the real attraction of Japan, says veteran fund manager Peter Cundill, is value. "The only market in the world that has a whole lot of cheap securities is Japan," he says. And when Cundill says something is cheap, he means seriously cheap. The 65-year-old native of Canada--he spends five months a year in London and the other seven in the U.S., Canada and Asia--is a devotee of Benjamin Graham's classic approach to stock valuation. Among other things, that means he sticks to companies trading for less than the shares would be worth if the firm were liquidated.

Cundill's IVY CUNDILL GLOBAL VALUE fund, which he manages with Hiok Hhu Ng, can invest anywhere in the world, but it currently has 40% of its assets in Japan. In addition to that big country bet, Cundill and Ng have decided to hold only about 25 stocks. Over the past three years, the fund ranks among the top 10% of world stock funds, according to fund-tracking firm Morningstar.

One gripe: With annual expenses of about 2% on shares with an up-front sales charge, the fund is costly. But even if you aren't ready to pay that kind of money, Cundill's willingness to take a stand on just a few stock picks makes his bullish take on Japan worth a listen. MONEY reporter Jonah Freedman spoke with Cundill at our New York City offices in early May.

Q. Japan's been in a slump for over a decade now. What made you decide there was money to be made there?

A. A couple of things. By 1997, the poor performance of the Nikkei got everybody in the market to give up, and a whole lot of corporations began to trade below net cash. But the major change has happened within the past year. Companies are starting to pay more attention to shareholder value. Traditionally there was no way for an individual shareholder to influence corporate events in Japan. But now we've broken in. For example, Warren Lichtenstein's Steel Partners did two hostile takeover bids in Japan in December. In both instances the companies raised their dividends, and their stocks went beyond their bid price. I think there will be more takeover and merger activity in Japan than heretofore.

Q. How long will it take for this trend to play out?

A. The culture of running a more profitable business is not as strong in Japan as it is in the United States. It's been emerging over the past decade, sometimes at what seems to be a snail's pace. In some ways, it's becoming a new Japan. But I'm not suggesting that this is a train hurtling through the station--we're in the beginning stages.

Q. Let's talk about how you pick stocks. You follow the Graham formula called "net net." How does that work?

A. You take a company's current assets and subtract all its liabilities--both short- and long-term--then you divide that by the number of shares. If that number is higher than the price of the stock, then you buy it. Let's say you have a company with one share. The company has current assets of $4 and current liabilities of $2, so working capital is $2. Then there's long-term debt of $1, so net net working capital is a buck. So if the shares are trading below $1, you do it.

Q. And when do you decide it's time to sell a stock?

A. That's a much more difficult question. The old rule was if the stock doubled, you'd sell half. Graham's formula was, if the shares went up 50% or nothing happened over two years, he'd sell them. That's our standard, but with a continual review process.

Q. Your investing model relies on digging through corporate accounting. Is that any harder to do with Japanese companies?

A. No, it's easier, because there haven't been a lot of mergers traditionally, and there are not a lot of intangible assets or goodwill on the books.

Q. So which Japanese companies are you investing in now?

A. We've seen value in non-life-insurance companies, such as NIPPONKOA INSURANCE. But this could apply to any sector. Video-game maker NINTENDO is another business I don't think is going away. It has huge cash balances--some in U.S. dollars--and no debt. It was trading at 22,000 yen two years ago; now it's at 10,000. I look at balance sheets first, and Nintendo has got a remarkably strong one.

Q. You also have two beverage companies, COCA-COLA WEST JAPAN and KIRIN BREWERY, in your top holdings.

A. Coca-Cola West Japan is Coke's Japanese distributor. Japan represents 20% of Coke's profits globally. The company has oodles of cash, lots of extra assets and little debt. With Kirin, if you sold off all its non-Japanese beer company assets, you'd be buying the beer company for zero. Kirin has been beaten up by its rival, Asahi, but is still a major force in the Japanese market.

Q. Is the Global Value fund a play on the weakness of the U.S. dollar?

A. We hedge for the most part, so I think we're probably indifferent to currency moves.