Tuesday, September 27, 2011


I recently read a comment that Japanese investors typically like to buy Sony stock at 0.7x or so book value per share (BPS).  That does sound a little cheap, so I took a quick look again, only to remind myself why I don't own too many Japanese stocks!

Sony really is a company that I would love to love.  I've known it as a kid and I have very positive memories associated with the Sony brand.  I am a big fan of Akio Morita and I grew up with the Sony walkman.

So this is a company whose stock I would love to own in a core portfolio for the long haul.  It's a solid, Japanese blue chip. 

But of course, you have to look at the business and not invest emotionally like that (that would be Howard Marks' first-level thinking!).  I decided to type this up because the same thing happens over and over in Japan as I still occasionally keep looking for interesting investment opportunities there.

Anyway, let's take a quick look at Sony.  The idea is that it is cheap on a P/B ratio basis.

The March 2011 annual report shows book value per share of 2,539 yen per share, and the closing price of the stock last night was 1,475 yen per share.   So Sony is not trading at 0.70x BPS, but a whoppingly cheap 0.58x BPS!

But wait a minute.  What difference does it make what the P/B ratio is if they don't make good money on that equity?  The standard measure for the attractiveness of a business is return on equity (ROE).

If a business can earn a nice ROE and you can buy that business at under BPS, that's a great combination:  Good business at an attractive price. 

So let's take a look at the ROE of Sony.  For reference, I also put the operating margin in the table.

Sony ROE and Operating Margin

                                     ROE                    Operating margin
2001                             13.60%                 1.80%
2002                               5.00%                 2.90%
2003                               3.80%                 1.80%
2004                               6.20%                 2.00%
2005                               4.10%                 3.00%
2006                               3.80%                 0.90%
2007                             10.80%                 5.40%
2008                              -3.10%                -2.90%
2009                              -1.40%                 0.40%
2010                              -9.40%                 2.80%
Five year average:            0.14%              1.32%
Ten year average:             3.34%              1.81%

This looks horrible.  The average ROE over the past ten years has been 3.34%, and over the last five was 0.14%.  Operating margins aren't much better.

Is a business that generates 3.34% return on equity attractive?  I think not at all.  Would I pay book value for such a business?  Of course not.  Would you pay a discount to it?   

Well, if you asssume they can do just as well as the last ten years and generate 3% ROE and you pay 0.6x book for it, that's an implied rate of return of 5%.  Not very exciting.  I would pass on this.

More worrisome is that in the last ten years, Sony was only able to achieve a double digit ROE in two years: 2001 and 2007.  I suppose 2001 was at the tail end of the internet stock bubble and boom times, and 2007 was also a boom time peak right before the housing collapse.

Now, if it takes the peak of a boom for SNE to make reasonable returns, that's not very encouraging.  I do remember 2007 being a flukishly good year for Sony.  I think they did well with the Playstation, large TVs, cameras etc...  U.S. and global consumers were spending like crazy.

And yet operating margin in that environment was only 5.4%.  Not so exciting. 

If those boom years didn't happen, then Sony's historical ROE would be even worse.

Every time I look at Sony, I wonder about the U.S. manufacturers of televisions, radios, stereo equipment etc... Where did they all go?  The Japanese basically took that market.

Is the same happening now in Japan?  Is Korea and China taking over those industries?  I think so.  Many Japanese used to tell me that there is no way that the Koreans and Chinese will catch up; that they don't have the technology to compete with the Japanese.  Ain't gonna happen.

But every single day, that becomes less and less true. 

At first, Sony lost a large block of business not just because of the Asians, but because the world went digital.  Their 'moat' or technological edge for a long time was in microelectronics etc...  They were able to make things smaller; smaller motors etc...

When the world went digital, all of that became useless.  This literally happened almost overnight.  And then Sony was late to enter the digital game (even though they do seem to have a large market share domestically in portable music players etc...).   But what is their 'edge' in the digital world?  All of that expertise they gained from manufacturing lost most of it's value.  Now you only need to wrap a chip with some plastic; no gears, tiny motors etc...

What about the Playstation?   It's also frightening to think that Sony's return on capital over the past decade includes some big business successes. 

The video game business is highly fluid.   Dominant players seem to change quite often, and the Apple iPod/iPhone and online PC gaming seems to be sort of a game changer.

In any case, I don't really have a deep understanding of each of Sony's business lines and I do acknowledge that this nominal, superficial cheapness will attract domestic and global investors to Sony and the stock price will probably go up when the global market stabilizes.

But from the simple above analysis, Sony really doens't look all that attractive.   I admit that I haven't picked apart Sony's balance sheet for mitigating factors to the above (for example, valuable holdings not earning returns on it's balance sheet, or hidden assets and other things), so there may be something else that makes Sony interesting.

For a long time, the Japanese stock market has seemed to be the most hated stock market in the world.  Of course, contrarians/value investors are always interested in looking where others don't.  I too have been interested in Japanese stocks for a long time for the same reason.

But time and again, every time you take a look at something, I realize why Japanese stocks haven't gone anywhere in decades.  Of course, the fact that it started at a ridiculous valuation in December 1989 accounts for much of the reason.   But the quality of the businesses from an equity shareholder point of view is just not attractive at all.  

No matter how cheap stocks look on a book value basis, it doesn't mean much unless the businesses can earn some decent ROE.

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