The Key Gauge of Abe’s Japan Inc. Revival Is Going Wrong Way

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The key yardstick of Prime Minister Shinzo Abe’s drive to make Japanese companies more profitable is heading in the wrong direction.

The Topix index’s return on equity fell to 8.2 percent at the end of March from 8.6 percent a year earlier, according to data compiled by Bloomberg after the latest annual reporting season. The measure of income relative to shareholder capital, a buzzword for companies and investors in the Abe era, is retreating after surging in the early part of his term.

The premier is partly a victim of his own success, says Bank of America Corp.’s Merrill Lynch unit. Even as Japan Inc. posts record profits, a rising stock market and weaker yen is boosting companies’ equity even faster. Firms are also keeping some of their earnings rather than returning them to shareholders or investing for growth.

ROE is “right in the middle of the report card, not bad but not very good,” said Gentoku Kiyokawa, the Tokyo-based director of investment at BNP Paribas Investment Partners Japan. Rather than clinging to cash, “companies need to decide to make capital investments or return it to shareholders.”

Equity returns for companies in the Topix climbed from 5.7 percent at the end of 2012 to March 2014’s peak as earnings surged. The measure languished at half the global average for much of the previous decade, a source of concern for Abe when he came to power.

His government’s steps to improve it included starting a stock index that picks the companies that do best at the metric, aiming to shame others into improving performance to make the cut. Japan set an 8 percent goal for ROE at public firms last year, its first such target.

Rise, Fall

The Topix has almost doubled under Abe, pushing up the market value of available-for-sale securities, which are included in equity on companies’ balance sheets. The measure slid 0.4 percent at the close in Tokyo today.

The yen has weakened 31 percent against the dollar during the period, increasing the value of companies’ overseas assets. It’s also helped send profits at companies on the Nikkei 225 Stock Average to record highs for the past two years. Much of that is being retained by firms, according to Merrill Lynch.

“Companies’ internal reserves were always going to get bigger when profit levels are so high,” Kenji Abe, an equity strategist at Merrill Lynch in Tokyo, said by phone. “The weak yen and higher share prices are also increasing mark-to-market valuations and making it difficult for ROE to rise.”

Still, with the Topix up 16 percent this year, Merrill Lynch’s Abe and Fukoku Mutual Life Insurance Co. don’t seem too worried about the decline.

“I thought ROE was still rising, so this is a surprise,” said Ichiro Yamada, general manager of equities at Fukoku Mutual Life. “Still, share prices are decided based on the price-to-earnings ratio, and earnings per share are still growing, so a decline in ROE doesn’t bother me.”

For more, read this QuickTake: Abenomics

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