Big value stocks have responded more significantly to the TSE demands with some enormous share buybacks announced during the earnings season from the likes of Toyota, MS&AD and Eneos.
The "learning" process still has a long way to go with smaller companies, but therein lies an opportunity.
Small-cap stocks have a forward price-earnings ratio of 12x and a price-to-book ratio of 1.1x, while the core 30 have a forward P/E ratio of 17.3x and a price-to-book ratio of 1.8x.
Taking into account the balance sheets, it seems to us that large caps trade at twice the multiple or more, which suggests a big gap has emerged.
With the Nikkei record, investors may think they have missed the opportunity, but the reality is that we are still at an early stage of management teams finally becoming aware of the cost of capital. We have not even begun to reduce what are clearly excess balance sheets.
We anticipate a surge of mergers and acquisitions (both divesting and investing) as well as outsourcing of non-core activities as firms realise how costly those operations and assets are in terms of capital.
Firms must both decrease total assets and be more selective in how they are used. The result will be a significant increase in return on invested capital along with valuations.
Other catalysts could be the weakness of the yen versus forecasts, further corporate governance news and a recovering Chinese economy combined with strength in the US economy.
There is a strong correlation between small caps and US interest rates, which if they begin to fall from mid-year could act as a tailwind for the sector.
So too will the corporate governance story as it trickles down the market-cap scale.
We have reached base camp and the easier money has been made in large caps. Now the real opportunity beckons for investors who can find those small and mid-sized companies, which can carry on the climb.
James Salter is chief investment officer at Zennor
