GAM Investments’ Japan Equities team discusses the opportunities artificial intelligence (AI) brings to the Japanese technology sector, citing Disco as a prime example.
07 November 2024
Chart 1: TOPIX Value versus TOPIX Growth (Performance from 30 December 2019 to 25 September 2023)
Source: Thomson Financial Datastream, Bloomberg, 25 September 2023.
Past performance is not an indicator of future performance and current or future trends.
Past performance is not an indicator of future performance and current or future trends.
Chart 2: TOPIX Value versus TOPIX Growth (Performance from 30 September 2023 to 29 October 2024)
Source: Thomson Financial Datastream, Bloomberg, 29 October 2024.
Past performance is not an indicator of future performance and current or future trends.
Past performance is not an indicator of future performance and current or future trends.
If we look back to the initial phase of Covid, growth stocks in Japan outperformed as companies expected to have good levels of earnings performed well. Then as we moved into the middle of the Covid period, market discussions shifted towards an inflationary period and interest rate hikes by the Federal Reserve (Fed) and other central banks; although not Japan's. This shift led to a preference for value stocks in Japan ahead of their growth counterparts, correlating with rising US Treasury yields. As yields increased, the discounting factor applied to growth stocks weighed on their P/E ratios, leading to a preference for value stocks.
By September last year, growth stocks started to emerge from Covid challenges. For almost a year now, the Tokyo Stock Price Index (TOPIX) value and growth indices have matched each other with only marginal differences. This aligns with easing long yields in the US, as the market believes inflation is under control and the Fed is starting its easing process. This has stabilised the overall picture, with growth and value now following a similar pattern. Analysts have raised the earnings forecast of growth stocks we favour, and we believe this is a strong argument for why these growth stocks should outperform in the coming years.
Disco: A key player in semiconductor manufacturing
When discussing growth stocks, semiconductors are undeniably crucial. Asia plays a significant role in the semiconductor supply chain, and Japan was once the world's leading chip manufacturer. Concerns over supply chains and geopolitical tensions have prompted the Japanese government to embark on a massive investment spree. The largest Japanese semiconductor stock by market cap, Tokyo Electron, stands as the fifth-largest semiconductor materials and equipment company in the world, following Dutch company ASML and the US firms Applied Materials , Lam Research and KLA Corp1. We are putting the spotlight on another key player: Disco. While Tokyo Electron is more focused on the front end of the manufacturing process, Disco is involved in the back end.
Disco is a Japanese precision tools maker, specialising in the semiconductor production industry. The company plays a critical role in semiconductor chip manufacturing, providing high-precision equipment and consumables for cutting, grinding and dicing wafers throughout the production process. Disco holds a 70% to 80% market share in this niche area of the chip manufacturing process. Its tools are used in the final stages to grind the back end of processed wafers, making them thinner, and then to cut or dice the wafers into many dies2, which are then packaged as finished chips. The beauty of its equipment lies in its ability to handle very valuable products at the final stage of manufacturing, giving Disco significant pricing power as clients prefer top-notch instruments in this critical area of the process.
Additionally, 20-30% of Disco's revenues come from consumables, which are used throughout the process and need to be reordered regularly. Along with parts and services support, this makes 40-50 of its revenues recurring and high margin. This business model is particularly advantageous during market downturns, giving it a defensive nature, which is beneficial given the cyclical nature of the semiconductor industry.
The new hot theme of AI and data centres also plays into Disco's business model. New data centres require high-bandwidth memory, stacking memory chips vertically. For example, the highly anticipated Nvidia Blackwell GPU will stack 12 memory dies on top of each other, requiring the dies to be thinner and increasing demand for Disco's high-value grinders, leading to better margins. We foresee strong growth potential and increasing margins for the company, despite already being at a high level.
The company’s share price fell 50% over the summer, presenting a good long-term buying opportunity in our view.
Reasons for our confidence in the market drivers
While AI remains a significant focus, the discussion on where growth will come from in Japan has become more balanced. Some investors are now questioning the long-term sustainability of hyperscaler investments, which we view as a natural outcome. We feel more comfortable when there are diverse opinions on this topic.
The strength of the yen has also played a role. As an exporting company, a stronger yen has pressured the share price. Additionally, the overall market sell-off and yen carry trade have contributed to the macroeconomic factors affecting the company. Despite these challenges, we believe in the company's long-term potential and that of similar growth-orientated stocks. We believe the AI story is just beginning, particularly with high-bandwidth memory and technological shifts in manufacturing; we expect this company and others to benefit significantly from these developments.
The semiconductor industry, while cyclical, is poised for growth. There are a few sectors in Japan with such a strong growth outlook.
Ernst Glanzmann, Lukas Knüppel and Katsuya Takeuchi manage Japanese Equity strategies at GAM Investments.
1Source: Bloomberg, as at October 2024.
2‘Dies’ or ‘dice’ is the plural form of die, which is the material on which a circuit is built. In the context of silicon wafers, the die is made of silicon. A die, wafer and integrated circuit each refer to different stages of the wafer manufacturing process. Once a wafer is created, it is divided into multiple dies, each containing a circuit. These dies are then cut into individual pieces, packaged, and turned into integrated circuits.
2‘Dies’ or ‘dice’ is the plural form of die, which is the material on which a circuit is built. In the context of silicon wafers, the die is made of silicon. A die, wafer and integrated circuit each refer to different stages of the wafer manufacturing process. Once a wafer is created, it is divided into multiple dies, each containing a circuit. These dies are then cut into individual pieces, packaged, and turned into integrated circuits.
Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Investors could lose some or all of their investments.
The TOPIX, or Tokyo Price Index, is a stock market index that tracks the performance of the Japanese economy. It's calculated and published by the Tokyo Stock Exchange (TSE) and includes over 2,000 stocks traded on the TSE. The TOPIX is a free-float adjusted market capitalization-weighted index that's used as a benchmark for investing in Japanese stocks. The TOPIX Style Index Series is comprised of 12 indices (TOPIX Value, TOPIX Growth, TOPIX Core30 Value, TOPIX Core30 Growth, TOPIX Large70 Value, TOPIX Large70 Growth, TOPIX Mid400 Value, TOPIX Mid400 Growth, TOPIX 500 Value, TOPIX 500 Growth, TOPIX Small Value, TOPIX Small Growth). References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark.
The foregoing views contains forward-looking statements relating to the objectives, opportunities, and the future performance of the markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Investors could lose some or all of their investments.
The TOPIX, or Tokyo Price Index, is a stock market index that tracks the performance of the Japanese economy. It's calculated and published by the Tokyo Stock Exchange (TSE) and includes over 2,000 stocks traded on the TSE. The TOPIX is a free-float adjusted market capitalization-weighted index that's used as a benchmark for investing in Japanese stocks. The TOPIX Style Index Series is comprised of 12 indices (TOPIX Value, TOPIX Growth, TOPIX Core30 Value, TOPIX Core30 Growth, TOPIX Large70 Value, TOPIX Large70 Growth, TOPIX Mid400 Value, TOPIX Mid400 Growth, TOPIX 500 Value, TOPIX 500 Growth, TOPIX Small Value, TOPIX Small Growth). References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark.
The foregoing views contains forward-looking statements relating to the objectives, opportunities, and the future performance of the markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.