Japan Insights - Market Strategy by Nozomi Moriya: TOPIX Reform - A Driver of Corporate Transformation

Japan’s TOPIX reform is set to intensify market discipline and push Japanese companies from disclosure and shareholder returns toward portfolio reshaping and growth investment.

• The first review phase, from October 2022 to January 2025, reduced TOPIX’s constituents from around 2,200 to roughly 1,700 by cutting the weight of less liquid stocks.
• The second phase starts on October 30, 2026, selecting stocks by market capitalization and liquidity regardless of market segment; the revised index will have fewer than 1,000 constituents, with the transition ending in July 2028.
• Since the Tokyo Stock Exchange’s 2023-era reform push, companies have raised dividends, bought back shares and unwound cross-shareholdings, but the author argues that these measures are only the beginning of corporate transformation.
• Companies should first optimize capital structures and reassess business portfolios, including exiting low-return operations, before directing capital toward M&A, AI-related fields, economic security and public-private collaboration.
• Japanese companies’ aggregate ROE is around 10%, versus roughly 15% in Europe and the United States; holding the cost of equity and growth expectations constant, a rise in ROE from 10% to 12% could lift PBR from approximately 1.7 times to 2 times, while 15% ROE could imply around 2.5 times PBR.

Takeaway: Japanese equities could still be revalued if companies respond to the investable-benchmark reform by improving capital efficiency, reshaping portfolios and investing for growth, although the PBR estimates are mechanical and actual prices depend on other factors.