Finding value in Japan

JAPAN’s equity market could extend its gains as stronger earnings, corporate reforms and rising nominal growth continue to support the investment case – but elevated valuations are making stock selection increasingly important.

Investors looking beyond the artificial intelligence (AI) boom may find opportunities in undervalued businesses as Japan’s changing economic landscape creates fresh catalysts for earnings growth and shareholder returns.

The challenge, though, is to identify companies whose future earnings potential is not yet fully reflected in their share prices, particularly after a strong rally since April 2025.

Ken Fisher, founder and executive chairman of Fisher Investments, takes an increasingly positive view of Japanese equities, arguing that the market is well positioned to benefit from a global shift towards value stocks after years of growth-stock dominance.

Japan is structurally a “value- based universe of stocks” rather than a growth-stock country, he says in a recent reel.

With growth shares leading global markets over the past decade or more, Japan’s market composition has held back its relative performance.

Its MSCI index averages a modest 7% return over the past decade, but the current environment could prove more favourable as value stocks regain ground against growth shares.

Fisher also points to increasingly aggressive bank lending in Japan as another catalyst. As companies gain access to financing for expansion, value-oriented businesses can become more active and adopt what he describes as a “growth mindset”.

Against this backdrop, Fisher Investments has moved its Japanese equity allocation from “underweight” to “neutral” or “slightly overweight” across most of its strategies.

Cautious stance

However, not all investors believe the market’s broad-based rally leaves sufficient room for an indiscriminate bullish strategy.

JPMorgan Private Bank notes that Japanese companies have enjoyed exceptionally strong earnings revisions this year, with 2026 and 2027 estimates now 16% and 14% higher, respectively, than at the beginning of 2026.

The upgrades have helped drive the Tokyo Stock Price Index (Topix) up 17% year-to-date.

Technology shares have benefited from investment in AI infrastructure, but earnings strength has also extended to industrials and financials.

Higher interest rates have been particularly supportive of banks as the Bank of Japan (BoJ) normalises monetary policy.

Despite expecting earnings growth of 25% in 2026 and 8% in 2027, JPMorgan Private Bank remains cautious about valuations.

It says valuations at a forward price-to-earnings ratio of 16 times are “mildly high relative to history”. The bank therefore retains a “neutral” view on Japan and is waiting for a better entry point before turning more decisively positive.

Standard Chartered Bank, meanwhile, maintains a core allocation to Japanese equities, citing stronger nominal economic growth and broad-based earnings revisions.

“Rising nominal economic growth is supporting solid broad-based earnings revisions, with rising rates supportive of bank earnings,” the bank says, adding that fiscal support for strategic industries is pro-growth and helps offset energy shocks.

Demanding phase

For investors seeking opportunities beyond the headline market rally, Eastspring Investments believes active stock picking and valuation discipline are becoming more important.

Head of Japan equities Ivailo Dikov and client portfolio manager James Ying write in a recent commentary that the investment case is entering a more demanding phase as familiar themes – including corporate governance improvements, easing deflation and Japan’s strategic position in the global technology supply chain – become increasingly reflected in share prices.

The MSCI Japan Index trades at around 15.6 times forward earnings, slightly above its historical average of about 15 times.

However, Eastspring argues that the valuation needs to be assessed alongside stronger profitability, improved capital efficiency and better shareholder returns.

Japan’s transition away from deflation is also changing the operating environment. Positive nominal growth, stronger wages and greater corporate pricing power could support structurally higher profitability than during the deflationary era.

Still, valuations vary significantly across the market.

As at Sept 30, the MSCI Japan Growth Index was trading at 18.4 times forward earnings, compared with 13.6 times for the MSCI Japan Value Index.

Consensus estimates point to earnings per share growth of 11.9% for the overall MSCI Japan Index in financial year 2027, compared with 25.7% for the growth index and 3.7% for the value index, based on data as at Oct 19.

The difference partly reflects sector composition, with growth stocks more exposed to technology, semiconductors and data centre investments, while value stocks have greater exposure to financials, automotive companies and trading houses.

For Eastspring, the key question is not simply which companies are growing fastest, but where future earnings could exceed market expectations.

“We currently see interesting opportunities in selected retail and service companies, industrials and banks,” Dikov and Ying say.

They also see opportunities among businesses exposed to AI-related investment, where sustainable earnings growth over the next three to five years could justify substantially higher valuations than current share prices imply.

However, they caution that expectations for AI and the broader Japanese market have risen sharply, making selectivity essential.

Corporate reform

Corporate reform remains another source of potential returns. Despite record dividends and share buybacks in 2025, Japanese companies continue to hold substantial cash reserves, creating scope for investment, acquisitions, restructuring and further shareholder distributions.

Eastspring notes that 57.7% of Topix companies are net cash positive, compared with 45.7% of MSCI Asia ex-Japan companies, 24.3% in the United States and 16.8% in Europe.

Shareholder activism is also gaining momentum, with campaigns increasingly targeting strategic decisions – including mergers and acquisitions, leveraged buyouts and portfolio restructuring – rather than simply demanding cash distributions or board changes.

The changing interest-rate environment offers both opportunities and risks.

The BoJ raised its policy rate in June and September, taking it to 1.25%, a 31-year high. Further gradual normalisation could support bank earnings, although a stronger yen raises concerns about exporters’ profitability.

Eastspring argues that the relationship between the yen and Japanese equities is neither consistent nor sufficient to explain market performance.

A stronger currency can also moderate imported inflation, while rising real wages may eventually support domestic consumption.

Japan’s real wages rose for an eighth consecutive month in August, although improvements in household spending and confidence have been gradual.

Proposed consumption tax cuts on qualifying food, subject to parliamentary approval, could provide additional support to household disposable income from April next year.

With valuations no longer broadly cheap and market expectations elevated, Japan’s next investment phase is likely to reward investors who distinguish between companies with genuinely sustainable earnings growth and those whose prospects are already priced in.