Were the Japanese Stock Prices Too High

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This is the question investors have been asking about the Japanese stock market. As can be seen from the chart below, an investment of one yen, placed in a diversified portfolio of Japanese stocks on the last day of 1969, would have grown to about 18 yen by 1988. By contrast, the tables in Chapter 9 can be used to show that a $1 investment in American stocks would have only risen to under $7 over the same time period. During this time period, the average price-earnings ratio for Japanese stocks was much higher than that for American stocks. For example, the Japanese P/E ratio was 54.3 in

1988, while the United States P/E ratio was 12.9 at the same time.*

However, as can be seen from the chart below, Japanese stocks took quite a fall after 1988. By the end of 1993, the 18:1 ratio had dropped to 9:1. It has stayed at about 9:1 over the ensuing years. By contrast, the U.S. ratio had risen from 7:1 to over 22. Not surprisingly, the P/E ratios had moved closer together. By the middle of 1997, the Japanese P/E ratio was approximately 44, while the American P/E ratio was about 21. This pattern has persisted into the year 2001.

Worth of an Investment of One Yen Made at the End of 1969 in Japanese Stocks

Is this a bubble?

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Data for this chart supplied by Yasushi Hamao. Reinvestment of dividends is assumed.

Worth of an Investment of One Yen Made at the End of 1969 in Japanese Stocks

Is this a bubble?

Japan Stock Bubble

*Actually, this disparity is partly due to differences in accounting treatments for the two countries. Kenneth R. French and James M. Poterba ("Were Japanese Stock Prices Too High?" Journal of Financial Economics 29 (October 1991), pp.

337-64) estimate that in 1988 the price-earnings ratio of Japanese firms would have been 32.1 instead of 54.3 had U.S. accounting practices been adopted.

Ross-Westerfield-Jaffe: I IV. Capital Structure and I 13. Corporate-Financing I I © The McGraw-Hill

Corporate Finance, Sixth Dividend Policy Decisions and Efficient Companies, 2002

Edition Capital Markets

Chapter 13 Corporate-Financing Decisions and Efficient Capital Markets 359

According to Malkiel,

The prize, however, must surely go to the unknown soul who started "A Company for carrying on an undertaking of great advantage, but nobody to know what it is." The prospectus promises unheard-of rewards. At nine o'clock in the morning, when the subscription books opened, crowds of people from all walks of life practically beat down the doors in an effort to subscribe. Within five hours a thousand investors handed over their money for shares in the company. Not being greedy himself, the promoter promptly closed up shop and set off for the Continent. He was never heard from again.25

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