Author: Aki Matsumoto

October stock prices rose toward the end of the month against the backdrop of a weak yen and strong U.S. stock market after the general election, after a decline due to concerns about the ruling party’s expected difficulties.

The CG Top 20 stock market outperformed both TOPIX and JPX400 for the sixth consecutive month in October.

October stock market began the month with a buy-back lead by higher U.S. stock market after a sharp decline at the end of the previous month. Thereafter, investors became more risk averse due to the view that the Liberal Democratic Party (LDP) would struggle in the general election. After the general election, the market rebounded and closed higher on the back of a relaxed sentiment, a weaker yen, and higher U.S. stock prices.

One year has passed since TSE requested companies to “manage their companies with an awareness of the cost of capital and stock price” (so-called “P/B raise”). As of the end of March, more than half (885) of the prime market listed companies had disclosed their measures, and more companies are expected to do so once the companies whose fiscal year ends in March begin to disclose their measures. In recent disclosures, some companies have broken down their ROE and indicated target values when referring to the cost of capital, partly as a result of TSE’s publication of good practices in disclosure materials.

I have discussed several times in my previous articles the widening gap between companies with large and small market capitalizations in terms of profitability and corporate governance initiatives. In this article, I would like to examine this issue. In my previous articles, “Increasing Profitability to Gain Support from Overseas Investors Is a Condition for Higher Valuation” and “Why Are Companies with High Corporate Governance Practices Ratings More Profitable?”, I stated that companies with high foreign ownership tend to have larger market capitalization and higher profitability. In addition, these companies also tend to have superior corporate governance practices. This is due to the fact that the companies have improved their profitability and corporate governance practices through years of engagement with overseas investors. Overseas investors have been calling for the need to improve the board of directors and the effective use of cash flow and cash on hand, including cash allocation, in order to increase corporate value. Based on our analysis to date, it appears that management is aware of the 30% foreign shareholding level as a threshold. Once this level is reached, there is a marked tendency to be forced to incorporate the opinions of overseas investors. It is expected that the engagement of overseas investors as a driver will further enhance the profitability and corporate governance of their portfolio companies (which tend to have large market capitalization). Thus, it can be inferred that the gap between companies with large market capitalization and those without will widen more and more.

In this article, I would like to discuss what trends are seen in companies with high corporate governance practice evaluations and what relationship there is between corporate governance practices and profitability and valuations of the companies.

Since February 2018, Metrical has evaluated a universe of approximately 1,800 companies using more than 40 evaluation criteria based on publicly available information such as annual securities reports, corporate governance reports, and financial statements, etc. which are updated on a monthly basis. Metrical also divides its corporate governance analysis into Board Practices and Key Actions. This is based on the hypothesis that for value creation, which is the goal of company management, improvements not only in board practices but also in board practices lead to decisions and actions (key actions), which in turn contribute to value creation. In other words, even if the composition of the board of directors and other aspects of board practices are formally put in place, they may not be utilized in management to create value. I believe that improvement of board practices should lead to actual actions and create value, which is what corporate governance improvement should be about. Below I discuss the relationship between the Metrical CG Score, which is evaluated based on this idea, and the companies’ profitability and valuations.

After a sharp downturn at the beginning of the month, the August stock market gradually calmed down and recovered much of the decline by the end of the month.
In August, the CG Top 20 stock market outperformed both TOPIX and JPX400 for the fourth consecutive month.

The stock market in August, which started following the 0.25% interest rate hike decided at the Bank of Japan’s July monetary policy meeting, fell sharply in confusion from the unwinding of the yen carry trade due to the significantly rising Japanese yen. Thereafter, the yen gradually regained its stability, and the US equity market was strong after passing key events such as Fed Chair Jerome Powell’s speech at Jackson Hole and Nuvidea financial results, which led to a buy-back Japanese stocks rally.
The TOPIX and JPX400 indexes fell 1.96% and 1.23%, respectively, in May, while the CG Top 20 index outperformed significantly both indices up by 2.89%.

The composites of CG Top 20 stocks has been replaced as of July 1.
The CG Top 20 has been revised as of July 1. EBARA CORPORATION (6361), TechnoPro Holdings (6028), ENEOS Holdings (5020), INNOTEC (9880), United Arrows (7606), and Persol Holdings (2181) were newly added to the list, while H.U. Group Holdings (2146), Kao Corporation (4452), Kao (4452), Wacom (6727), K’s Holdings Eisai (8282), and Trend Micro (4704) were removed. (2146), Kao (4452), Wacom (6727), K’s Holdings (8282) Eisai (4523), and Trend Micro (4704) were removed. Details of the component stocks are shown in the table below.