The table below lists the current and historical P/E ratio, CAPE ratio and dividend yield of the Japanese stock market, calculated using all public Japanese companies listed on the Tokyo Stock Exchange. The trailing price-earnings ratio of the Japan equity market is currently 27.70 and CAPE ratio is 31.90 (12/31/2020). The ratios are calculated based on the standard reporting practices of Japan in which earnings/losses generated by subsidiaries not entirely owned by the parent company are not fully recognized. If the P/E and CAPE ratio would be calculated using complete consolidated earnings of the public companies, the P/E ratio would be 22.53 and CAPE ratio would be 24.26. The table includes also the P/E ratio of the Nikkei 225 index.
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Japan Stock Market (all public companies): P/E, CAPE Ratio & Yield
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Historical valuation of the Japanese equities
The chart below shows the historical CAPE ratio of the Japanese stock market since the year 1988. The graph includes also the 3-year forward return of thr TOPIX equity index which illustrates the relationship between CAPE ratio and stock returns (note that the axis for the forward return is inverted). The forward return means the total return of the TOPIX index of the next 3-year period. A negative correlation between the ratio and stock market performance can be seen even though the returns during the recent years have remained low despite historically low valuations.
We have calculated two different version of the CAPE ratio. The first version uses the so called “official” P/E ratios of the Japanese companies while the second version is calculated using the consolidated earnings of the companies. The difference between these two versions was especially large during the years before the financial crisis of 2007-2008 when the Shiller PE ratio calculated using unconsolidated earnings was larger than one hundred.
Consolidated and unconsolidated earnings of the Japanese public companies
The valuation of the Japanese stock market has always been considered high compared to the rest of the world and this has raised a lot of questions how can the valuation multiples of Japanese stocks be continuously higher than their Western counterparts.
The main reason for the perceived high valuations of Japanese stocks is the way how corporate earnings are recognized when valuation multiples like P/E ratios are calculated. Instead of fully consolidated earnings of a parent company and all its subsidiaries, the common practice is to use earnings that do not fully include earnings and potential losses of all subsidiaries owned by the parent company.
The differences between accounting practices between Japan and e.g. the United States have been widely discussed. One of the earliest comprehensive studies of the accounting differences was done by Kenneth French and James Poterna in February 1990 when the authors published their working paper “Are Japanese Stock Prices Too High?”. In their paper, French and Poterna came to the conclusion that if Japanese firms would use U.S accounting rules, the P/E ratio for the Tokyo Stock Exchange would have been 32.1, not the reported 54.3, at the end of 1988. However, the authors highlight that the accounting differences are unable to explain the sharp rise in the Japanese stock prices during the mid-1980s and it would be reasonable to assume that the Japanese equities were valued much higher than their fair market value at the time.
About CAPE (P/E 10) ratio
Cyclically adjusted price-to-earnings was popularized by Professor Robert Shiller who introduced the ratio to evaluate the historical valuation of the S&P 500 index. The ratio is calculated using the following method: index price level divided by the ten year average earnings-per-share of the index, both adjusted for inflation. It has been demonstrated that a higher CAPE ratio is associated with lower than average stock returns. Professor Shiller is publicly sharing his dataset for S&P 500 that is kept up to date. Examining the Excel file is the easiest way to examine how the ratio is calculated.