Dan Carter, Fund Manager, Global, considers the question of how one can quantify a company’s competitive advantage. By some measures, it’s an area where many Japanese companies score well on a global basis. This goes some way to answering the question: “why bother with Japan at all?”
Fund managers in general are rarely faced with questions from clients which could be considered existential. Except, apparently, if those managers are investing in Japanese equities when questions such as “why bother with Japan at all?” are common. We are by now well practiced in our response to such lines of enquiry.
In previous articles I have addressed topics such as our views on the structural improvements in Japanese profitability, the beneficial impact of the country’s corporate governance revolution and the low valuations on the market. Another, less easily quantifiable reason in my view is that so many Japanese companies are just very, very good. The issue here is the definition of ‘good’. A Western business school definition, which is based upon the efficient use of a company’s capital, admittedly shows Japan in a fairly dim light. Take a different perspective, however, one which focuses upon expertise, know-how and intellectual property, and Japan begins to shine.
This perspective is important to us because expertise, know-how and intellectual property are so often the basis for the competitive advantage we require in our investee companies. The issue is how to quantify this; no single method is perfect.
Japan’s strength in intellectual property
Some insight can be gained by analysing the size and quality of companies’ patent portfolios. Research firm PatentSight has not only quantified the number of patents owned by companies but also attempted to evaluate their value as implied by the number of times they are cited in other patent applications. As a proxy on intellectual property this is imperfect, but it is interesting to note that of the fifteen companies globally with the most valuable patent portfolios fully one-third are Japanese including, names such as Canon, Hitachi, Panasonic and Sony. By this metric Japan is clearly doing something right.
Some of the companies that rank well by that measure are in the same or similar business: Samsung, Huawei, LG Electronics, Intel and Microsoft for example. But Toyota is a notable outlier – none of the other global auto makers are anywhere close. The main reason is that for twenty years the company has been a pioneer in alternative drivetrain technology through its hybrid system. This is also the reason why Toyota is ahead of its rivals in satisfying stringent upcoming emissions requirements.
Investment in R&D
Another way to get a read on Japanese-held intellectual property is to look at the inputs – how much does the corporate sector spend on R&D? The short answer is a lot. If the combined R&D expenditure of TOPIX-listed companies was an economy, at $141bn it would be just outside of the top 50 globally – just ahead of the whole of the Kuwaiti economy.1 Almost a quarter of TOPIX-listed companies spend more than 4% of sales on R&D and a tenth of companies spend more than 8% of revenues on R&D.2
Once again this method is imperfect, Japanese companies could, and in some cases will, be wasting a lot of money in the lab. However, another company example shows that this kind of analysis can offer some insight – this time the name is Asahi Intecc, a global leader in guidewires for minimally invasive cardiovascular surgery. Here is a company which spends more than 10% of its sales on R&D3 but with an almost non-existent patent portfolio. The reason for this is not that the company is wasteful in its research and development but that its core technology – the drawing of fine, strong wire with perfect torque transmission – remains unpatented by choice. What better way to protect ones’ intellectual property than to keep it a secret?
Japan’s detractors are many and their arguments are well known. In the absurd competition to be ever more pessimistic about the market, virtues become invisible and opportunities are missed. But this is our day job. Our eyes are wide open to the great businesses in Japan, even if they require a little bit of understanding, and we remain alive to the investment opportunities they offer.
1 Bloomberg, July 2019. IMF 2018
2 Bloomberg, July 2019
3 Bloomberg, July 2019