The 5 Best Japanese Stocks With the 5 Best Formulas for Value Investing
In the coming weeks, I will rank the top-5 performing Japanese companies through the lens of the 5 most powerful formulas known to Value Investors!
In the coming weeks, I will embark on a journey to rank the top 5 performing Japanese companies through the lens of the 5 most powerful formulas known to Value Investors!
Why Using Formulas?
Value investing formulas are simple, rules-based systems designed to bring high returns within reach. By following a simple, algorithmic approaches, formulas allows investors to easily identify outperforming or undervalued companies without letting emotions or instinct cloud their judgment.
Of course, nobody should blindly trust a formula for their investment decisions, but its usually the best first step to find those golden nuggets in any market.
The 5 Best Formulas
Below I have chosen the five best formulas for value investing based on their track record, their fame and my own opinions. These are the formulas I intend to apply to the Japanese stock markets in the coming weeks to syphon out the greatest golden nuggets Japan has to offer:
The Graham Number
This is the formula that started it all! Benjamin Graham (1894-1976), often referred to as the "father of value investing", was a renowned investor and professor at Columbia University. He released the bible of value investing, The Intelligent Investor, in 1949, that has been constantly updated until Graham’s death in 1976.
In it, he wrote out a formula called The Graham Number which has helped value investors beat the market consistently.
The Graham strategy is based on a company meeting as many of the seven specified criteria as possible. A company’s score is ranging from zero to seven depending on how many of the criteria the company meets in these seven areas:
Size - companies too small will have a less reliable future in downturns
Financial Strength
Earnings Stability
Dividend History
Earnings Growth
Moderate P/E ratio
Moderate price for Book Value (BV)
Magic Formula
The Magic formula was first described in the 2005 best-selling book The Little Book That Beats the Market and in the 2010 follow-up, The Little Book That Still Beats the Market by investor Joel Greenblatt.
It relies on quantitative screens of companies and stocks, and is designed to beat the stock market's average annual returns using the S&P 500 to represent the market return. Put simply, it works by ranking stocks based on their Earnings Yield (Earnings Before Interest and Taxes(EBIT)/Enterprise Value (EV) ) and returns on capital(EBIT/Invested Capital).
Piotrinski’s F-Score
Piotroski’s F-score is named after Stanford accounting professor Joseph Piotroski and is number between 0 and 9 (nine being the best) which is used to assess strength of company's financial position.
The score is calculated based on 9 criteria divided into 3 groups:
Profitability
Return on Assets (1 point if it is positive in the current year, 0 otherwise);
Operating Cash Flow (1 point if it is positive in the current year, 0 otherwise);
Change in Return of Assets (ROA) (1 point if ROA is higher in the current year compared to the previous one, 0 otherwise);
Accruals (1 point if Operating Cash Flow/Total Assets is higher than ROA in the current year, 0 otherwise);
Leverage, Liquidity and Source of Funds
Change in Leverage (long-term) ratio (1 point if the ratio is lower this year compared to the previous one, 0 otherwise);
Change in Current ratio (1 point if it is higher in the current year compared to the previous one, 0 otherwise);
Change in the number of shares (1 point if no new shares were issued during the last year);
Operating Efficiency
Change in Gross Margin (1 point if it is higher in the current year compared to the previous one, 0 otherwise);
Change in Asset Turnover ratio (1 point if it is higher in the current year compared to the previous one, 0 otherwise);
The score is calculated based on the data from financial statement of a company. A company gets 1 point for each met criteria. Summing up of all achieved points gives Piotroski’s F-score (number between 0 and 9).
The Peter Lynch Strategy
In the early 1980s, a young portfolio manager named Peter Lynch was becoming one of the most famous investors in the world, and for a very understandable reason – when he took over the Fidelity Magellan mutual fund in May of 1977 (his first job as a portfolio manager), the assets of the fund were $20 million. Between 1977 and 1990, he proceeded to turn it into the largest mutual fund in the world, outperforming the market by a mind-boggling 29% per year annualized!
Lynch accomplished this by using very basic key numbers to filter out companies that have high profit growth to low valuation:
Growth is valued in the form of low PEG (Price/Earnings to Growth Ratio). In addition, stable sales and Earnings Before Interest and Taxes growth as well as a stable cash flow, profitability and a market cap lower than $4 billion USD.
The Warren Buffett Strategy
Last but not least, I have included the main strategy from arguably the most famous value investor of all time, Warren Buffet!
His main investing principle is that people should only buy stocks in companies that exhibit solid fundamentals, strong earnings power, and the potential for continued growth.
Hence, the Warren Buffet strategy filters out companies that have high returns on equity and total capital and good profitability in the form of high margins. In addition, it ranks companies by how stable their cash flow is and their debt ratio to ensure that the business has no major capital needs.
Summary
These are the 5 strategies I intend to filter out Japanese companies with. I want to emphasize that anyone using them need to through research beyond the formulas before they invest.
At minimum, reading the companies financial statements, checking their ownership base, following up on the trends in their industries, and comparing them with peers is a must before putting any actual $$ into them.
However, in the coming weeks, I can assure you that golden nuggets will be handed out to you, so keep your eyes open!