Nikkei 225

The Nikkei 225 (also known as the 'Nikkei Stock Average') is Japan's most famous and widely quoted Stock Market Index. Think of it as Japan's equivalent to the Dow Jones Industrial Average (DJIA) in the United States. It tracks the performance of 225 large, publicly owned, and actively traded companies on the First Section of the Tokyo Stock Exchange (TSE). First calculated in 1950, its history provides a fascinating, and at times terrifying, lesson for investors everywhere. The index is published daily by the Nihon Keizai Shimbun (The Japan Economic Journal), which is where the “Nikkei” name comes from. For many global investors, the Nikkei 225 serves as the primary barometer for the health of the Japanese stock market and, by extension, its broader economy. Understanding its unique construction and dramatic history is essential for anyone considering investing in Japan or simply wanting to grasp the highs and lows of modern market cycles.

The most important thing to know about the Nikkei 225 is that it's a Price-Weighted Index. This is a relatively rare method today, shared by its American cousin, the DJIA. Imagine you're creating a “shopping basket index” of 225 items. A price-weighted method simply adds up the price of each individual item to get the total. So, a company whose stock trades at ¥10,000 has ten times more influence on the index's movement than a company whose stock trades at ¥1,000, regardless of the company's actual size, revenue, or total market value. This is different from most modern indices, like the S&P 500, which are market-capitalization-weighted. A market-cap-weighted index would give more weight to the bigger company (the one with a higher total value), not just the one with a higher share price. This price-weighting can lead to some quirky results:

• Distorted Influence: A company with a very high stock price can have an outsized impact on the index, even if it's not one of Japan's largest businesses.
• Stock Split Effect: When a company performs a Stock Split (e.g., a 2-for-1 split where the share price is halved), its influence on the Nikkei is also halved, even though the company's total value hasn't changed. To manage these distortions, the index uses a special divisor that is adjusted for stock splits and changes in the index's components.

For a Value Investor, the Nikkei 225 isn't just a number; it's a story packed with powerful lessons.

The Nikkei 225 is infamous for its role in the Japanese Asset Price Bubble of the late 1980s. Fueled by speculative euphoria, the index soared to an all-time high of 38,915 on December 29, 1989. At its peak, the grounds of the Imperial Palace in Tokyo were rumored to be worth more than all the real estate in California. What followed was a catastrophic crash and the beginning of Japan's “Lost Decades”. The index plummeted, and even over 30 years later, it has struggled to reclaim that historic peak. This provides a stark, real-world lesson on the dangers of:

• Paying any price for growth: The belief that “this time is different” and that prices can rise forever is a recipe for disaster.
• Ignoring valuation: At the bubble's peak, Japanese stocks were trading at absurdly high price-to-earnings ratios.
• The illusion of permanent highs: Markets can and do go down, sometimes for a very, very long time. An investor who went all-in at the peak in 1989 would have faced devastating losses.

The shadow of the 1989 bubble has, for a long time, made investors wary of Japan. However, this has created potential opportunities for disciplined value investors. Many world-class Japanese companies, from automakers to electronics giants, now trade at reasonable or even cheap valuations compared to their global peers. In recent years, a push for better Corporate Governance has encouraged many Japanese firms to become more shareholder-friendly. They are beginning to unwind complex cross-shareholdings and return more cash to investors through Dividends and Share Buybacks. This means that beneath the headline number of the Nikkei 225, there are individual companies with strong balance sheets, global brands, and attractive prices waiting to be discovered.

• What it is: The Nikkei 225 is Japan's leading stock index, tracking 225 Blue-Chip companies on the Tokyo Stock Exchange.
• How it's built: It is a price-weighted index, meaning stocks with higher prices have more influence, which is a key difference from market-cap-weighted indices like the S&P 500.
• The Value Investing Lesson: The Nikkei's epic boom and bust in the late 1980s and 1990s is a classic reminder to never overpay for an asset, no matter how popular it is.
• How to invest: You can't buy an index directly, but you can invest in it through financial products like an Exchange-Traded Fund (ETF) or an index fund that tracks the Nikkei 225.