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The just-released 2Q CY23 data on aggregate corporate profits in Japan was somewhat mixed, but the overall corporate recurring pre-tax profit margin rebounded near its record high on a four-quarter average. The non-financial service sector rose to another record high, but the manufacturing sector fell further from its record high. The former sector’s pre-tax profits grew 19% YoY due to increased margins and revenues, while the latter’s was flat YoY after significant YoY declines in the prior two quarters. The long-held theme of this report (since 2006) that profit margins remain on a structural uptrend, despite sluggish domestic GDP growth, still holds (although recent nominal GDP growth is assisting to some degree) and domestic and international investors finally realise that Japanese corporations are delivering solid profits and shareholder returns, with the increased expectation that such will likely continue over the intermediate term. Indeed, the large, continuing corporate price hikes are very surprising to long-term observers of Japan. Consumers are quite unhappy with such, especially if their after-tax wages are not growing faster than such, but local and global investors in Japanese equities are reaping the benefits.

Four-quarter average pre-tax profit margin vs. Japanese nominal GDP YoY growth
(for all non-financial companies, not just listed ones)

Four-quarter average pre-tax profit margin vs. Japanese nominal GDP YoY growth Sources: Japan Ministry of Finance, Bloomberg, data through CY2Q23

Non-manufacturers (excluding financials):

Non-manufacturers (excluding financials) Sources: Japan Ministry of Finance, Bloomberg, data through CY2Q23

Manufacturers:

Manufacturers Sources: Japan Ministry of Finance, Bloomberg, data through CY2Q23

One should also note that the Ministry of Finance statistics cited in this report do not cover after-tax income, and due to corporate tax cuts nearly a decade ago, the overall net recurring profit margin has expanded even more sharply than the pre-tax data shown above, allowing shareholders to benefit from higher dividends and share buybacks. Also due to buybacks, EPS has been (and still is) growing even faster than net profits.

It seems that the myth that Japanese companies do not reward shareholders is finally dispelled now, and, thus, the P/E ratio for the market has risen. However, valuations remain attractive, especially for long-term investors. Some investors likely still worry about low Japanese economic growth, but this report’s theme should greatly help dispel such. Forward EPS estimates continue to rise in Japan, as well. However, Japan’s MSCI in USD terms has not outperformed MSCI World this year, which means that Japan is hardly in a bubble or even over-bought. Thus, given the increased global realisation of Japan’s improvements, outperformance versus global markets seems highly probable.