Survival Kit for an Equity Analyst. Shin Horie
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Value, Metal Spread (2008–2013)
In 2008, I passed on my coverage to a colleague and became the Director of Japan Equity Research. On top of all the personnel-related matters, one of the main responsibilities of the Director of Research is quality control of the research product. From day one, for all analysts in Japan, I was required to give advice and approval for rating changes, new thematic reports, and coverage initiations via the Investment Review Committee. I had spent the previous 10 years thinking in depth about semiconductors and hardware technology, and had only limited ideas about other industries. There were many unusual words, such as cap rate, embedded value, phase three clinical trial, and metal spread. I needed to digest and study. Sometimes I spent hours discussing the dynamics of certain industries with analyst teams until midnight. It was a fascinating experience and I felt like a whole new area of my brain not previously used had been turned on.
Having attended these Investment Review Committee meetings for a few months, I was getting used to giving advice to real industry experts on their investment views. I found it absolutely fascinating to see that even 10-year or 15-year industry veterans have blind spots. As they know the industries so well and are deeply wedded to the sectors, they could sometimes miss some of the more obvious future trends. For example, when I was an analyst, a mistake I made in hindsight was being too slow to acknowledge the disappearance of film cameras and then also the decline of dedicated digital cameras. Since I knew how quickly the specifications of CMOS (complementary metal-oxide semiconductor; essentially the eye of the digital camera) image sensors and lens technologies had been progressing as a semiconductor analyst, I should have predicted the major decline of digital cameras earlier.
In a similar vein, discussions with the auto sector analysts on electric vehicle transition were also interesting. Auto-sector analysts have often said in the past that the pure electric vehicle adoption would likely be slow because the batteries are too heavy and too expensive, and automakers did not want to focus on this business because it was loss making. But I argued that I had seen many technologies advance faster than expected when the whole industry focused their efforts on it, and also it is ultimately the consumer who decides what to buy, not the car makers. While I don't think I always get the advice right, listening to the analysts present their high-level views and quickly identifying the blind spots without knowing too much detail is an extremely valuable skill I learned through the experience. I really wished I had listened to presentations by other analysts more when I was a coverage analyst and figured this out earlier.
During my tenure as the Director of Japan Equity Research, Japanese equity was not popular with investors – low profitability, slow to implement changes, poor corporate governance, and fierce competition from the rest of Asia. One day in 2010, when I went to see a client in Edinburgh, Scotland that was known for long-term selective investing, the veteran portfolio manager told me that our research was useless because it did not address the core value of a company at all. Hence, he gave no business to us. He said he was only interested in Japanese companies that he could buy, forgot about for five years, and that would outperform the market. I went back to Japan, discussed with our analyst population and decided to launch a ‘Japan 2020’ series. This research series was basically to select several companies in Japan where the analysts felt strongly about sustainable growth potential in the next 10 years and then undertook a deep dive on the industry structure analysis and prepared 10-year financial projections. Some reports took almost six months to prepare and the research team successfully published a number of Japan 2020 reports in the following 12 months. Those reports were very well received, in particular by overseas investors who had historically disliked Japanese equities. The corporates also appreciated our efforts. It was a great learning tool for our analysts to go beyond the normal forecast time horizon. A year later, I went back to Edinburgh to see the same portfolio manager and I was very pleased to find he had read all of the Japan 2020 reports in detail.
Importing DM Experience to EM: From Japan to Asia-Pacific (2014–2017)
When my immediate boss in Hong Kong retired, I was asked to run the Asia-Pacific equity research department with a very talented British colleague. Even though I had experience in Korean, Taiwanese, and Mainland China markets through my technology research, I lacked confidence that I could lead the complex Asia-Pacific region with 11 offices and 13 different markets. Although I would not characterize the transition as easy, it was a lot smoother than I anticipated. Many of the skills and experience I had accumulated as an analyst in Japan readily transferred to other markets. With a little sensitivity towards cultural differences, the process of training junior analysts and motivating senior analysts was surprisingly similar in different countries, not easy but similar.
Even more pleasing, I found I was able to help analysts deepen and broaden their thoughts on a number of industries in emerging markets (EM) by providing my experience from developed markets (DM). When we wanted to analyse the future of the convenience store business in Thailand and Taiwan, we had to study the history of the industry in Japan and Korea in detail. If we need to have a 20-year vision of the supermarket business in India, we have to study US supermarkets in the 1970s. Japanese furniture chain stores could give us strong insights into the future of Chinese furniture makers. When we wanted to conduct long-term steel demand forecasts for India, it was very insightful to compare ‘steel intensity’ (consumption of steel versus GDP) across various different countries. It sounds a very basic thing to do but I was surprised to find not many analysts in these growth markets spent sufficient time learning from the histories of developed markets.
When I started to lead the Investment Review Committee in Japan and to deal with the industries I was unfamiliar with, I needed to develop the skills to pick up the salient points quickly without knowing all the detail. Having been involved in the Japanese equity market for almost 20 years by then, if I heard the name of the major listed companies, I at least had a rough idea of what they all did. But when my remit expanded to Asia-Pacific, I could not even pronounce the names of the majority of companies. It was not easy to provide sensible advice to improve the quality of analysis and to avoid pitfalls just listening to 20–30-minute presentations about companies I had never heard of.
The tools that helped me substantially during this learning period included ‘time machine analysis’ and ‘pattern recognition analysis’. Time machine analysis simply compares development of the same industry across different countries. Pattern recognition compares different industries in different counties with similar industry dynamics. For example, an analyst wanted to argue that Chinese steel companies would go through a consolidation phase as a result of the regulations linked to severe emission requirements, and that this would result in less earnings volatility and higher stock valuations. However, while there were no obvious examples in the steel industry to illustrate the impact of these changes, the hard disk drive industry in the United States had been through similar changes in the past. So, the analyst was able to study the dynamics of the hard disk drive industry over several years and see whether there were any similarities with the Chinese steel industry. Although none of these analysis tools can make a perfect magic mirror, they can give provide a bit more conviction to our view.
The import substitution theme in the Chinese market was another really interesting example of leveraging DM knowledge to EM. When I was visiting China regularly as an analyst during the period 2000 to 2008, China was already widely known as ‘the factory of the world’ and was manufacturing a variety of products to export to global markets. But the factory managers I met often said that while they were able to source most of the basic parts from China, certain key components and materials had to be sourced from Japan or Europe, which prevented them from further cost reduction. Following that, I started to notice some Chinese companies gradually localizing the manufacturing of such key parts and materials, while at the same time the government was pushing the upgrading of manufacturing industries. I thought it would become a prevailing growth theme and looked for companies who would benefit from this shift. One good recent example as a continuation of this theme was a manufacturer of hydraulic components used for construction machinery. The Chinese company basically produced a similar quality of hydraulic components with a lower cost compared to Japanese companies and thus has steadily replaced the latter in the Chinese market over the past several years.
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