In 1853 Commodore Matthew Perry led four warships into Tokyo Bay and politely asked could Japan be “Friends” with the US. This was no ordinary trading request. The Japanese had done their own Brexit hara-kiri way back in 1639 and had cut themselves off from the rest of the world over the following two centuries. Foreign visitors faced the death penalty, as did cooperative locals, for any defiance of the powerful Shoguns’ wishes so the island nation was relatively friendless by the time Perry arrived. However, the Commodore displayed strong diplomatic skills, kept his head (literally) and benefitted from a Japanese leadership realisation that Rwanda wasn’t really an option to stop the boats and that they had fallen too far behind the rest of the world. As a prescient show of outside progress, Perry’s ships anchored off Yokosuka boasted an arsenal of new Paixhan guns. These French inventions were the first naval guns to fire explosive shells and were an acute reminder of Japan’s need to catch up industrially and militarily. And… quickly. Only a few years later, after accepting American trading overtures, Japan returned to centralised government; restored its Meiji emperor and rapidly industrialised the country. The shoguns and samurai were gone. The railways, factories and armies were built and there was a new economic “Shogun” leading the global trading charge.
The new “Shoguns” were family-controlled business conglomerates like Mitsubishi, Mitsui and Sumitomo and were known as zaibatsu. More importantly, for current discussion, these zaibatsu set up trading companies to source commodities, manage transportation and arrange financing across potentially hundreds of companies within a family business group. These trading houses with 150-year histories are a bit older than Warren Buffett but in many ways the Sage of Omaha’s investment vehicle, Berkshire Hathaway, shares common ground with these firms which became known as sogo shosha after World War II. So, we shouldn’t be so surprised Buffett has been in the news recently having boosted his stakes in five Japanese trading firms; Mitsubish Corp, Sumitomo, Marubeni, Itochu and Mitsui. In fact, their shared skill-sets, prompted Buffett to hint that his interest in these firms goes beyond just holding them as portfolio stocks. Ok, so there’s a degree of strategic sense in Buffett’s look eastward but why now? Well, Buffett doesn’t exactly hide his investment thinking or processes. His annual letter to Berkshire Hathaway shareholders is a must-read for any investor with lots of common-sense analyses and current investment market examples. However, the underlying principles in the stories never change. Japan’s trading houses are merely the badges, so let’s consider the investment principles.
Valuation: Warren’s famous steer that “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price” still holds true. The check list for Buffett’s fab five Japanese trading firms looks pretty good when we consider their inflation-hedge characteristics (commodities), market access and connections (China/India) plus seriously strong cash flow. Traditional valuation metrics support “fair price” or even better with a forward P/E less than 7x, expected dividend yields above 5% and current earnings yields of 14% to support that expectation. Yep, a good price but as the Sage would say “Price is what you pay, value is what you get”. The intrinsic value and strength of an investment is driven by the quality of a business and that needs to be checked too.
Quality: My favourite Buffettism is “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains..” That won’t cheer up Chelsea supporters but the cash flows, market intelligence, connectivity and longevity of the sogo shosha are instructive as to Warren’s managerial ambition. My other thought is that the modern business world has witnessed the explosive global power and wealth creation of ‘platform businesses’. From stock exchanges, to Google, to Bloomberg, to Meta, to Amazon, to Microsoft or to SaaS the “value” is derived from the connectivity of the platform, the network effect. One suspects a 150 year trading history in Asia gives these firms serious ‘platform’ characteristics and……. opportunities.
Growth: One of Buffett’s huge success factors is that he avoids “value traps”. In other words, businesses can be bought for cheap prices, but for a very good reason. Often, that reason will be a sclerotic road to obsolescence. Think Nokia, Blackberry, Tupperware or Blockbuster. Cash generation and sales alone won’t stop franchise attrition. A good or growth company must have opportunities to deploy capital and compound returns. So, I was struck by Buffett’s comment that “These five companies are a cross-section of not only Japan, but of the world”. Then, I thought of these three data points:
- Two thirds of the world’s middle class will live in Asia by 2030.
- The US has overtaken China as India’s top trading partner; activity now valued at $122 billion annually.
- This US-Indian trading relationship in American sporting parlance might be “still in the early innings”. Check out Apple who have just opened their very FIRST retail store in India this week; not just any week, but the week the UN announced that India’s population had surpassed that of China at 1.4826 billion citizen consumers.
The connections of sogo shosha firms are going to become very valuable. As long-term financiers in the region they must be shown nearly every deal going. And if, we are valuing market intelligence, how about…. data?
Economic Moat: Buffett says, “In business, I look for economic castles protected by unbreachable moats”. The trading houses’ network of relationships, size and funding liquidity would be traditional sources of competitive advantage but there’s more. In these frantic weeks of generative AI and the scary march of the chatbots one would be forgiven for thinking all economic models are facing extinction-level disruption. Well, maybe not. In fact, the nimble quick disruptors of the past five digital decades might face a very different moat. Big established businesses already have huge data to train their AI internally. Think about Bloomberg who have just announced their own AI chatbot, but with a difference. This bot is trained with the best financial data/intelligence in the world, and Bloomberg’s enormous moat just got bigger. Now think about huge platform businesses like the ones Buffett just bought in Japan.
Whatever about Buffett’s assertion that his new portfolio holdings “are a cross-section…of the world”, it feels to this writer that the ‘cross-section’ of Asia’s middle-class consumer and AI is going to be a very big deal, involving seismic shifts in power. Indeed, barely fifty years after Commodore Perry’s landing at Yokosuka, the modernised military forces of Japan embarrassed the super-power of the time, Russia, in Manchuria. However, the consequences of the Russo-Japanese War were global, not Asian. The shock of Russia’s defeat forced a re-calibration of geo-politics in both Europe and Asia, but still failed to stop the Bolshevik revolution in October 1917. Buffett is watching Asia carefully again. We should too.