The shrinking Japanese workforce is not the cause of this woeful performance, he says. Since 1989, the nation’s annual per capita GDP has been 1.75 per cent, compared to 1.5 per cent from the US. Theoretically, the EPS of Japanese equities should have more than doubled since 1989, but now stands at roughly the same level. Inker says Japan’s lost years have been caused by rampant share issuance from companies in an economy growing slowly. As EPS was spread among an increasing number of shareholders, it fell far short of its potential, making dilution an “unmitigated disaster” for the Japanese market. Dilution is also a looming problem in the US market. At the close of 2008, its quarterly net share issuance rate spiked to 5.7 per cent, a level higher than any recorded since the 1950s.

In a diluted market, companies with capital shortfalls are more attractive because any equity they raise will most likely be put to work in acquisitions or operations that will create growth and drive EPS higher, rather than shoring up balance sheets. “The share issuance we’re really interested in is the issuance needed to repair the balance sheets of companies,” Inker says. “If you have raised relatively expensive equity to pay off relatively cheap debt, you have a problem. You wake up and find yourself over-levered.” Dilution with no EPS growth indicates that a company’s balance sheet is “unsustainably over-levered”. It seems likely that Australian equity managers will soon be diagnosing which capital-hungry businesses in their portfolios display this symptom.

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