English Translation Of Presentation By Y. Ohta

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Transcript

The Security Analysts Association of Japan
Seminar Proceedings
Contents
I. Intellectual asset-based management and capital markets.....................................2
II. The quantification of business risk…………………………………………………….12
III. From business risk assessment to company risk management……………………23
IV. Example of using the business risk assessment model as
investment information………………………………………………………………….27
Conclusion……………………………………………………………………………………35
Value Creation through Intellectual Asset-Based
Management and Business Risk Quantification
Yoko Ohta, CMA
Senior Researcher
Quantitative Research Department
Nomura Securities Co., Ltd.
This is an English translation of the Japanese proceedings published by the Security Analysts
Association of Japan (SAAJ). The presentation comes from the SAAJ event held on 28 May 2007 in
Tokyo.
Translated by Nomura Securities Co. Ltd, Tokyo, with permission from SAAJ.
2
I. Intellectual asset-based management and capital markets
Intellectual assets are the particular strengths and characteristics of a company, which are
the source of its competitive advantage. For example, a company’s intellectual assets may
be the aggregate of invisible, intangible assets such as its unique technology, brand power,
business model strengths, personnel capabilities, and organizational merits. Business
based on the efficient use of intellectual assets is called intellectual asset-based
management and the pursuit of intellectual asset-based management can result in the
continuous generation of value, leading to an increase in enterprise value. If a company
improves its disclosure related to how it creates value based on its intellectual assets,
stakeholders can accurately assess the company’s latent value, thereby narrowing the gap
in awareness between the company and the market, allowing the share price to approach
fair value and reducing the risk of a takeover.
1. The process of value creation via intellectual assets-based management
1
The process of value creation via intellectual asset-based management
Bus iness  
strategy
us ing  intellectual 
capital
Internal control
E nterprise R isk
Management (E R M)
Higher intellectual
asset value
and 
competitive power
S trengthening  of 
management power
Appropriate and 
effective disclosure
on intellectual as sets
and practical 
use strategy
Higher appraisal
in capital market
C ost of capital↓
E nterprise value↑
M&A  risk↓
Assessment in 
the capital market
[ Chapter 1. Intellectual asset-based management and capital markets ]
Source: Nomura Securities Co. Ltd, Tokyo
Source: Nomura Securities Co., Ltd. Tokyo
The process of value creation via intellectual asset-based management involves a business
strategy based on intellectual assets and feedback via market appraisal (Exhibit 1). This
process starts with the company's managers clearly identifying the company's intellectual
assets and how best to use them and then formulating business strategy accordingly. The
successful implementation of this strategy then requires the construction of a system for
effectively managing intellectual assets, and the efficient functioning of internal controls.
This enables the company's management itself to experience the company's potential for
value creation, but it is important that the internal intellectual assets are displayed for
appraisal on the outside, by means of appropriate and effective disclosure. Such disclosure
can result in appraisal by external analysts and investors and this further increases the
company’s appetite for intellectual asset-based management, thereby driving up the
3
market’s and investors' appraisal of the company's potential value and resulting in lower
financing costs and higher enterprise value for the company.
I identify three important points in this process. First, managers must have a clear
understanding of the company's intellectual assets and must marshal these assets in the
best interests of the business. The second point is effective disclosure. The final point is
appropriate appraisal of the disclosed information by the appraising parties. I look at these
three points in more detail below.
2. Management of intellectual assets~The process of ERM
2
② Event Identificationt I tifi ti
Management of intellectual assets~The process of ERM
1)Risk assessment methodsi t t

R
isk
Assessm
ent
R
isk
Assessm
ent
2)Assessment of each riskt f i
3)Assessment of
relationship between risks
t f
l ti i t i
4)Assessment of
residual risk
t f
i l i
1)Risk tolerances and
Risk appetite
i t l
i tit

R
isk
R
esponse
R
isk
R
esponse 2)Portfolio viewtf li i
⑤ Control Activities and Monitoringt l ti iti it i
B
usiness units
W
hole com
pany
w hole group
Risk mapping(Estimating likelihood and impact)
Allocation of risk capital
Estimation of risk capital
Assessment of relationship between events
Identify internal risk factors and
external risk factors
Identify type of risk(positive/negative/both)
Assessment of residual risk
Qualitative method
Quantitative methods(Probabilistic models:VaR,
EaR, etc, Non-probabilistic models:sensitivity
measures, scenario analysis, etc)
Management of inherent risk
Costs versus benefits of potential responses
Maximize enterprise value
Reporting、IT、Role and Responsibility
Source: Nomura Securities Co. Ltd, Tokyo
① Objective Settingj ti ttiWholeCompany
l Select risk tolerances and risk appetite
Assessment of relationship between risks
Organization
[ Chapter 1. Intellectual asset-based management and capital markets ]
Source: Nomura Securities Co., Ltd. Tokyo
In order for managers to understand clearly the company's intellectual assets and marshal
those assets in the best interests of the business, a target management system, or more
specifically a framework for managing intellectual assets in tandem with a risk management
system, is required (Exhibit 2). This involves the implementation of enterprise risk
management (ERM). At present many Japanese companies are busily engaged in
improving their internal controls (to comply with the Financial Instruments and Exchange
Law, the so-called Japanese version of the Sarbanes-Oxley Act), which I regard as a part of
ERM. Exhibit 2 shows the five stages of ERM, which is a continuous process. This process
depends upon first clearly defining the concepts and targets of ERM, then sharing them and
screening for risk at individual business units. Next, risk is appraised quantitatively and
qualitatively at the individual businesses, with consideration of measures to counter serious
risk and quantitative assessment of residual risk. The perspective then shifts from individual
business units to the group as a whole, with management considering its overall risk
strategy from the viewpoint of the overall business portfolio and then deciding on actual
strategic measures. Finally, the process is repeated as a part of daily business activities,
while it is refined and improved via the fifth stage of control activities and monitoring. The
most important part of the process is the fourth stage of devising and implementing
4
measures to counter risk based on risk’s likelihood impact (instead of, for example, simply
providing disclosure based on the Financial Instruments and Exchange Law), after having
appraised risk in the third stage.
3. Management of intellectual assets~ERM and risk responses
3
E nterprise R isk Assessment
Maximize E nterprise Value
Accepting R educing Avoiding
Methods  of E RM
S haring
R isk C apital
Mergers  & Acquis itions
Operational
(ex.  Hedge  of currency 
risk, Local production)
R eal Option
(R eduction, s top, 
postponement, 
withdrawal of investment 
plan)
Derivative
S ecuritization
Insurance
Management of intellectual assets~ERM and risk responses
[ Chapter 1. Intellectual asset-based management and capital markets ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 3 shows risk responses. The wide range of risk management methods includes
internal management by accepting risk or reducing it, hedging risk via capital markets, and
transferring risk to other parties. In principle, enterprise value should be boosted by a
forward-looking strategy of reducing unnecessary risk and accepting necessary risk,
thereby managing risk.
5
4. Management of intellectual assets~ERM and role of capital markets
4
Management of intellectual assets~ERM and role of capital markets
Companies
(offering risk)
Investors
(Accepting risk)
Capital Markets
(redistribution of risk)
・ Companies is reducing unneeded
risk and concentrating business
resources on risk to accept for
higher enterprise value.
・ If investors cannot find the type of risk that
they are looking for in the markets,
financial product manufacturers can
process risk into the right form to satisfy
investors' demand
・ The capital markets in this way redistribute
risk for companies, thereby providing them
with greater business flexibility.
[ Chapter 1. Intellectual asset-based management and capital markets ]
・ Investors can fulfill their asset
investment needs by carefully
selecting needed risk from
among the unneeded risks
companies offer .
Source: Nomura Securities Co., Ltd. Tokyo
In order for a company to drive up its enterprise value through ERM, three different parties
must each play their roles, namely, the capital markets, the company, and investors (Exhibit
4). Capital markets are formed by companies offering risk and investors accepting risk and
then enabling risk transactions and the redistribution of risk. Investors can fulfill their asset
investment needs by carefully selecting needed risk from among the unneeded risks
companies offer. If, for example, investors cannot find the type of risk that they are looking
for in the markets, financial product manufacturers can process risk into the right form to
satisfy investors' demand. The capital markets in this way redistribute risk for companies,
thereby providing them with greater business flexibility.
6
5.Disclosure of intellectual assets~Three disclosure methods
5
Disclosure of intellectual assets~Three disclosure methods
The guidelines  for intellectual asset‐based management reporting  is sued in 2005 by ME T I 2
Companies share with stakeholders their visions of value creation over the medium and long terms based on
intellectual assets.
It is expectable that the justification of a company valuation by capital market increases.
Intellectual assets  and C S R  are two s ides  of the same coin1
The many company is putting power into appeal of CSR now.
Companies should be able to raise their value by appealing to the markets via its concentration of resources on
its intellectual assets.
As for the company which has large business risks, it is desirable to describe its earnings forecast in a range.
Close to fair value by reducing unnecessary volatility of stocks.
Disclosure of earnings  forecast ranges  (the TS E  report) 3
[ Chapter 1. Intellectual asset-based management and capital markets ]
Source: Nomura Securities Co., Ltd. Tokyo
The second important point is that after establishing internal management systems, a
company carries out effective disclosure related to its intellectual asset-based management.
No matter how important intellectual asset-based management may be, the company will
find itself unable to continue its efforts if it cannot gain the understanding and positive
appraisal of stakeholders for its activities and investments. As such, it is essential for the
pursuit of intellectual asset-based management that managers and stakeholders see eye to
eye and that disclosure is accurate. Exhibit 5 shows three disclosure methods. The first is
the disclosure of intellectual assets from the viewpoint of corporate social responsibility
(CSR). The second disclosure method is based on the guidelines for intellectual assetbased management reporting issued two years ago by METI. The third is the TSE's
disclosure method.
7
6. Disclosure of intellectual assets~Intellectual assets and CSR
6
Disclosure of intellectual assets~Intellectual assets and CSR
Intellectual assets  and C S R  are two s ides  of the same coin.
The  intellectual assets  which  is  the  fountainhead of value contributes  to society  through value creation of a  
company.
What is  the intellectual assets  for a  company is  evaluated as  C S R  for society.
Intellectual 
property
R &D
IT
P ersonnel 
capabilities
S ys tematic  
correspondence 
power
C ustomer base, 
Power 
corresponding  to a  
customer, 
Brand name
Others ,
R esult of 
mid‐term and 
long‐term 
investment
Intellectual 
creativity 
in the whole of 
society
L abor s tandards , 
Labor environment, 
Human rights ,
P ersonnel training
C ompliance
S atis faction of 
a  consumer,
S afe  guarantee of 
a product and 
service,
F air competition
E arth environment, 
E nvironmental 
protection, 
Local contribution, 
C reation of local 
investment, 
Philanthropy
IA
In a  s imilar way to C S R , a  company should thus  be able to raise  its  value by appealing  to the markets  via  its  
concentration of resources  on its  intellectual assets . 
[ Chapter 1. Intellectual asset-based management and capital markets ]
C S R
Source: Nomura Securities Co., Ltd. Tokyo
Disclosure based on CSR (Exhibit 6) has recently been regarded by the markets as having
great importance, in response to which companies have been stepping up their efforts in
this direction. As shown in Exhibit 6, the elements involved in intellectual assets are very
similar to the elements of CSR. Intellectual assets and CSR are two sides of the same coin,
based on the view that the intellectual assets generated by a company contribute to society.
In a similar way to CSR, a company should thus be able to raise its value by appealing to
the markets via its concentration of resources on its intellectual assets.
8
7. Disclosure of intellectual assets~METI ”the guidelines for intellectual asset-based
management”/Elements and KPIs as proofs
7
Disclosure of intellectual assets~METI ”the guidelines for intellectual asset-based
management”/Elements and KPIs as proofs
[ Chapter 1. Intellectual asset-based management and capital markets ]
(1) Management stance/
L eader ship
【K ey E lements  of C orporate Value】
•Degree of internal penetration of management principles
•E xternal transmission of information by top manager
•Development of future leaders  (average age of subsidiary presidents)
【E xamples  of Indic ators】
•Amount of environment‐related investment
•Number of S R I funds  which adopted the corporation
•C orporate image survey and ranking  results
•C ompliance system     Diversification of risks
•Number of public announcements  regarding risk 
information and speed of public  announcement of problems
•R isk of being an acquisition target
•C ompensation claims  in pending lawsuits
•R isk of information leakage
•In‐house improvement proposal for quality control system
•Number of lateral projects     J ob leaving ratio
•Degree of employees’ satisfaction     Incentive system
•R&D  costs  vs. sales       Outsourced R&D  cost ratio
•Number of IP  owned, economically meaningful term
•Employees’ average age and increase/decrease from
the previous  year      New products  rate
•Weighted average of market share of main 
products/ services  of the main business
•Degree of customer satisfaction
•New customer sales  ratio or growth rate of new customers
or members  compared to those in the previous  year
•P rice pass‐through capability     Negotiation power
•F inancing capacity
(2) S election and C oncentration
(3) E xternal negotiation power/   
relationships
(4) Knowledge C reation/ 
Innovation/ S peed
(5) Teamwork/ Organizational
knowledge
(6) R isk Management/
Governance
(7)C oexis tence in society
•C ompetitiveness  of major business
•Weighted average of the numbers  of companies  providing
the same products/serv ices      Employee assessment
•R eview performance of unprofitable department
•Degree of R&D  concentration     Differentiation of market
S ource: METI
Source: METI
The second method is based on the guidelines for intellectual asset-based management
reporting issued in 2005 by METI. METI proposes that companies share with stakeholders
their visions of value creation over the medium and long terms based on intellectual assets
and METI has accordingly drawn up instructions for such disclosure. That is to say,
companies should first explain what has been accumulated by the business in the past and
what kind of value has been generated, or else the reasons why profits were not generated.
After that, companies should identify future uncertainties, disclose their methods for dealing
with such uncertainties, and reveal the strategy decided upon for the use of intellectual
assets accumulated previously. To ensure that management's future vision is not
groundless speculation, METI proposes the disclosure of supporting materials composed of
51 universal items for the quantitative appraisal of intellectual assets (Exhibit 7). These
items go beyond the financial data usually prioritized by analysts to cover a wide range of
intangible asset information in areas including personnel, organization, risk management,
and social responsibility, to provide a basis for common quantitative assessment.
Companies are first required to provide a persuasive description of the value creation
process and then to back it up by means of reliable quantitative indicators and continuously
disclose data. The aim of this is to enable communication between the company and its
investors via a common language on intellectual asset-based management leading to value
creation over the medium and long terms.
Regarding the third method, the TSE describes as follows the effectiveness of disclosing
earnings forecast ranges, in a study group report on earnings releases. The TSE says that
earnings projections have a major impact on share price formation and that companies
should disclose an earnings estimate range and then explain the business conditions and
other assumptions for the upper and lower limits of this range. As such, not only METI but
9
also the market authorities have started to encourage more detailed disclosure of
information related to the range of risk factors that can affect share prices.
Even if companies step up their efforts to disclose information, however, there is still the
problem of whether the appraisers of this information really understand it. If understanding
on the appraisal side does not improve, the end result is likely to be useless efforts. I thus
identify the third important point to be the improvement of capabilities on the appraisal side.
If the role grows for people capable of analyzing disclosed information on intellectual assets
in a sophisticated way, then the recommendations of existing analysts are also likely to
improve.
8. Assessment of intellectual assets~Risk measurement in capital markets
8
Assessment of intellectual assets~Risk measurement in capital markets
First, in risk management, it is important to specify the factors constituting the cause of risk generating and
to clear risk structure.
If risk factors are specified, it will be easy to consider the correspondence method to the risk.
The advancement of risk structure analysis leads to the advancement of company risk management.
Identification of Risk Factors
Stock return of company i=beta of company i × market return +intercept +residual risk of company i
Stock price movements are influenced by various common factors, such as macro-economic factors
(interest rates, currency rates, prices, weather, oil price), industry group, and fundamental data and so on.
Finding out common factors, and managing them rationally.
Equity Factor Model
imii rr εαβ ++=
iiiii FFFr εαβββ +++++=  ・・・ 
332211
Market component eigenvalue
・・・Formula ①
・・・Formula ②
[ Chapter 1. Intellectual asset-based management and capital markets ]
Source: Nomura Securities Co., Ltd. Tokyo
Based on the foregoing observations, I have devised a business risk assessment model as
a new way of assessing companies (Exhibit 8). This seeks to measure business risk by
applying to business earnings the stock factor model, which is a popular quantitative model
used by institutional investors to select stocks. My model is a new tool for communication
between investors and companies that applies to business risk the concept of the stock risk
model widely used as a yardstick in capital markets.
10
9. Assessment of intellectual assets~Development of the business risk assessment model
9
Risk model using only publicly disclosed information and data.
Characteristic of the model is to consist of public risks peculiar to each business and some private risks for the
purest possible business unit. Common risk drivers reflected the contents of each business for every industry,
and it is assumed that it has played the important role in explanation of the value chain of each business unit.
Risks (business risks) in each business unit can be identified from an objective viewpoint.
Model A:Business risk model using only publicly disclosed data (general purpose model)
The model which measures the risk of the whole company can be developed by adding the information about the
private risk in which the original value creation story of the company is made to reflect as risk drivers based on
Model A.
Business risk structure changes also with public risks as well as private risk every day. And results changes also
for analytical methods or the purpose. Moreover, it is declared in the report of METI that “business risk is unique
for every company and it is not measured and estimated by the uniform model”. Therefore, a unique business risk
model is needed for each company.
The point is how to grasp private risk quantitatively. However, generally quantification of a private risk is difficult.
Model B:Customized business risk model
Assessment of intellectual assets~Development of the business risk assessment model
[ Chapter 1. Intellectual asset-based management and capital markets ]
Source: Nomura Securities Co., Ltd. Tokyo
The model is divided into two types (Exhibit 9). Model A is a general-purpose model for
appraising business risk using only publicly disclosed data. Model B is a customized model
for appraising business risk that also uses the company's unique private risk represented by
its intellectual asset-based management. We actually provide our clients with Model B
based on Model A.
11
10. Assessment of intellectual assets~Application of METI indicators to business risk model
10
Assessment of intellectual assets
~Application of METI indicators to business risk model
[ Chapter 1. Intellectual asset-based management and capital markets ]
(1) Management stance/
Leader ship
【K ey E lements  of C orporate Value】
•Degree of internal penetration of management principles
•E xternal transmission of information by top manager
•Development of future leaders  (average age of subsidiary presidents)
【E xamples  of Indic ators】
•Amount of environment‐related investment
•Number of S R I funds  which adopted the corporation
•C orporate image survey and ranking  results
•C ompliance system     Diversification of risks
•Number of public announcements  regarding risk 
information and speed of public  announcement of problems
•R isk of being an acquisition target
•C ompensation claims  in pending lawsuits
•R isk of information leakage
•In‐house improvement proposal for quality control system
•Number of lateral projects     J ob leaving ratio
•Degree of employees’ satisfaction     Incentive system
•R&D  costs  vs. sales       Outsourced R&D  cost ratio
•Number of IP  owned, economically meaningful term
•Employees’ average age and increase/decrease from
the previous  year      New products  rate
•Weighted average of market share of main 
products/ services  of the main business
•Degree of customer satisfaction
•New customer sales  ratio or growth rate of new customers
or members  compared to those in the previous  year
•P rice pass‐through capability     Negotiation power
•F inancing capacity
(2) S election and C oncentration
(3) E xternal negotiation power/   
relationships
(4) Knowledge C reation/ 
Innovation/ S peed
(5) Teamwork/ Organizational
knowledge
(6) R isk Management/
Governance
(7)C oexis tence in society
•C ompetitiveness  of major business
•Weighted average of the numbers  of companies  providing
the same products/services      Employee assessment
•R eview performance of unprofitable department
•Degree of R&D  concentration     Differentiation of market
S ource: ME TI
Source: METI
Using general-purpose model A it is possible to discount the shaded portion in Exhibit 10 of
METI's 51 universal indicators described earlier in the terms of detailed business risk and
appraised enterprise value. The biggest obstacle to this kind of quantitative analysis is
insufficient data, but analysis should become easier if companies follow METI’s instructions
and make progress in accumulating and disclosing such data. Furthermore, if progress is
made in disclosing values related to the qualitative items that are not shaded in Exhibit 10,
the data could be used in customized model B as information on the company's unique
intellectual assets.
Finally, it is important that managers engaged in intellectual asset-based management
implement their own strategies, while also sharing a correct understanding of the
relationship between share price and credit rating (the key appraisal methods of capital
markets) on the one hand and the company's exposure to risk on the other. The size of a
company's risk is reflected in its enterprise value via costs of capital and companies with
high exposure to enterprise risk exhibit low enterprise value as a result of investors
demanding relatively high costs of capital. The requirements for obtaining a high credit
rating are the stable generation of cash flow and low financial risk. A rise in enterprise risk
results in greater cash flow uncertainty and higher credit risk, in turn causing a lower rating
and higher financing costs. This then results in the need for more risk capital, or in other
words, the additional shareholders' equity.
12
II. The quantification of business risk
11. Current status on ERM in most of Japanese companies
11
② Event Identificationt I tifi ti
Current status on ERM in most of Japanese companies
1)Risk assessment methodsi t t

R
isk
Assessm
ent
R
isk
Assessm
ent
2)Assessment of each riskt f i
3)Assessment of
relationship between risks
t f
l ti i t i
4)Assessment of
residual risk
t f
i l i
1)Risk tolerances and
Risk appetite
i t l
i tit

R
isk
R
esponse
R
isk
R
esponse 2)Portfolio viewtf li i
⑤ Control Activities and Monitoringt l ti iti it i
B
usiness units
W
hole com
pany
w hole group
Risk mapping(Estimating likelihood and impact)
Allocation of risk capital
Estimation of risk capital
Assessment of relationship between events
Identify internal risk factors and
external risk factors
Identify type of risk(positive/negative/both)
Assessment of residual risk
Qualitative method
Quantitative methods(Probabilistic models:VaR,
EaR, etc, Non-probabilistic models:sensitivity
measures, scenario analysis, etc)
Management of inherent risk
Maximize enterprise value
Reporting、IT、Role and Responsibility
Source: Nomura Securities Co. Ltd, Tokyo
① Objective Settingj ti ttiWholeCompany
l Select risk tolerances and risk appetite
Assessment of relationship between risks
Organization
[ Chapter 2. The quantification of business risk ]
Costs versus benefits of potential responses
Source: Nomura Securities Co., Ltd. Tokyo
Most of Japanese companies have generally completed stages one and two in Exhibit 11,
but have passed on to stage five with outstanding uncertainties in the essential third and
fourth stages. However, the third and fourth stages are the most important for ERM actually
to result in value creation. At present, few companies have a clear idea of the detailed
effects of risk management on their enterprise value. I think that the following model is
effective for stages three and four.
13
12. Two perspectives of enterprise risk
12
Two perspectives of enterprise risk
Two pers pec tives  of ris k
E nterpris e R is k  
R educe negative  impact by E RM Increase pos itive  impact by E RM
■ C ompliance
■ L awsuit
■ R umor
■ Natural disas ter
■ Incident, Accident, F ire, E arthquake
■ C ountry risk
■ S ystem down
■ environment
■ C S R
■ Macro economic  (Overseas  macro‐economics , 
domestic  macro‐economics , population, customs  
duty, regulation)
■ S emi‐macro economic  (life  s tage, market s ize, 
regulation, suppliers/dependencies , currency)
■ C ompetition (bus iness  s trategy, share, prices , 
cost, quality, inves tment, M&A, R&D)
■ F inancial (finance, asset management, credit, 
capital structure, risk capital, liquidity)
■ Employment(pens ion)
Opportunity
Bus ines s  ris k
C ris is
C ris is  ris k
L ikelihood =low
Impact=high~huge
L ikelihood=high
Impact=low~high
[ Chapter 2. The quantification of business risk ]
Source: Nomura Securities Co., Ltd. Tokyo
The first thing to look at is the risk assessment methodology for individual business units.
Risk requiring management by companies can be divided into two main categories (Exhibit
12). In other words, the fundamental concept of ERM is to maximize enterprise value via the
appropriate management of crisis risk and opportunity risk. Many companies start by
assessing crisis risk, but there is a low likelihood of this type of risk by its nature and it
should be covered by a certain level of risk capital. It is earnings opportunity risk (business
risk) instead of crisis risk that should be managed on a daily basis. Opportunity risk occurs
daily and is the source of value creation and the assessment and management of this type
of risk is the prerequisite for value creation by means of ERM. The first step in this process
is the clear identification of the sources of future cash flow.
14
13. Identification and structuring of risk factors (Inference Diagram :ID)
13
Risk factors are structurized and an influence diagram is designed.
Operating profit is divided into the item P/L and public risks and private risks of relating to each item are sorted out.
Public risks affect competing companies equally and are beyond the control of a single company. Private risks are unique to a particular
company and are the sum of its intangible assets. It is the easiest to evaluate public and quantitative risks, and it is the most difficult to
evaluate private and qualitative risks.
Identification and structuring of risk factors (Inference Diagram :ID)
Operating profit
Cost rateQuantity sold Price
Share
[Political]
・Regulation
・Taxation system
R&D
ContractPatent
Investment
Finance
[Economic]
・Economic trend
・Inflation
・Currency rates
・Interest rates
[Social]
・Population
・Life level
Maturity
[Technology]
・Innovation
Regulation
Personnel Blanding strategy
P/L
Private RiskPublic Risk
Semi-macroeconomics
Ordinary course
of business
Economic trend
in industry
Macroeconomics(Domestic, Global)
[ Chapter 2. The quantification of business risk ]
Source: Nomura Securities Co. Ltd, Tokyo
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 13 illustrates the risk screening process. Business risk is the source of business
value and this is divided into two main categories. The first category is public risk, which
affects competing companies equally and is beyond the control of a single company. The
second category is private risk, which is unique to a particular company and is the sum of its
intangible assets. The two risk categories together in the end have an impact on the likes of
operating profits. The structuring of these factors is the first stage of appraising business
risk.
15
14. Example of ID
14
256Mb 1Gb
Example of ID
Digital TV
DVD
Recorder
Digital
camera
・・・ Risk driver
PC
Cellular
phone
Digital
appliances
Operating profit
Cost
Sales volume Price
Numbers Share
Sales
This is an example of an inference diagram for the semiconductor business.
Risk drivers of giving the serious impact for operating profits are extracted.
From variable analysis using historical data, the risk factors enclosed by red circle in the above figure are
identified as risk drivers.
Yield rate
512Mb
[ Chapter 2. The quantification of business risk ]
Source: Nomura Securities Co. Ltd, Tokyo
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 14 shows an example of this, namely, an inference diagram for the semiconductor
business. As shown in the exhibit, operating profits are divided into levels to break down the
business risk factors not included in accounting data.
15. Estimation of impact by risk drivers and identification of important risks
15
In tornado chart analysis, we are comparing the size of impact of each risk driver to operating profit, and giving priority
to manage.
Right figure: Weight of risk = (Risk of an optimistic scenario + abs(Risk of an pessimistic scenario))/Σ(Risk of an
optimistic scenario + abs(Risk of an pessimistic scenario))。In this case, risk from product price changes, risk from
yield rate changes and Risk from fall of the shipment number of digital TV have large impact on operating profit of the
semiconductor business.
Left figure: Risk from product price changes makes up 40% of total risk and has a very large impact on business value.
Estimation of impact by risk drivers and identification of important risks
[ Chapter 2. The quantification of business risk ]
4,000
10,000
12,000
-4,000
-30,000
-12,000
-20,000
-9,000
-35,000 -30,000 -25,000 -20,000 -15,000 -10,000 -5,000 0 5,000 10,000 15,000
1Gb:変動リスク
DVDレコーダー台数:低下リスク
デジタルTV台数:低下リスク
歩留り:変動リスク
商品価格:変動リスク
企業価値からの±1σ変化分(百万円)
C hanges  from value in base scenario
(-10%)
(-30%)
(-5million)
(-20%)
(+10%)
(+10%)
※( )precondition
(-10million)
Weight of risks
(+20%)
8.9%
19.8%
23.8%
39.6%
7.9%
0% 10% 20% 30% 40% 50%
1Gb:変動リスク
DVDレコーダー台数:低下リ
スク
デジタルTV台数:低下リスク
歩留り:変動リスク
商品価格:変動リスク
±1σ change of value (Million yen)
Source: Nomura Securities Co. Ltd, Tokyo
Risk from product price
changes
Risk from yield rate changes
Risk from fall of the
shipment number of
digital TV
Risk from fall of the
shipment number of
DVD recorder
Risk from 1 Gb changes
Risk from product price
changes
Risk from yield rate changes
Risk from fall of the
shipment number of
digital TV
Risk from fall of the
shipment number of
DVD recorder
Risk from 1 Gb changes
Source: Nomura Securities Co., Ltd. Tokyo
16
The various risk factors can be represented on a tornado chart like Exhibit 15, to show the
degree of risk incurred within assumed parameters. This shows the level of value fluctuation
for each risk factor, enabling identification of the greatest risk factor. In the example shown,
risk from product price changes makes up 40% of total risk and has a very large impact on
business value. Stated differently, management’s strategy needs to focus on the risk from
price fluctuations. Moreover, the scale of price fluctuations reveals the very large risk of
business value falling in response to lower product prices.
16. Business value distribution
16
Business value distribution
トータル事業リスク分布
0
50
100
150
200
250
5
0
,0
0
0
1
0
0
,0
0
0
1
5
0
,0
0
0
2
0
0
,0
0
0
2
5
0
,0
0
0
3
0
0
,0
0
0
3
5
0
,0
0
0
4
0
0
,0
0
0
4
5
0
,0
0
0
(百万円)




無相関
A sample of multi-dimension Monte Carlo simulation by multi risk drivers.
The base scenario is located on the right of average, so this is recognized as an optimistic scenario.
Minimum
Maximum
Plan achievement ratio
Average
Median
(Million yen)
Enterprise value of a base scenario
300,000(million)
Average/Risk
Risk(-1σ):
Downside risk from average
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 16 shows the total business risk from all of the various risk factors occurring at the
same time and the fluctuation range for expected business value. This plotting of business
value distribution makes it possible to assess where on the scale lie, for example, the
company’s projections in its medium-term plan, as well as the likelihood of their attainment.
The example in the exhibit has an attainment likelihood of 20%, suggesting that the
medium-term plan’s projections are rather aggressive or challenging. In other words, the
plan’s targets look very likely to be revised down. Company managers can adjust the
appeal of their IR activities by understanding something of this distribution when
announcing their plans and by recognizing the feasibility of their projections. In terms of the
company's internal management, when targets are actually attained the company can
appraise the level of the difficulty that was overcome. If this distribution is also taken to
represent market value expectations, it implies that the market does not understand
management’s value creation vision when the share price is at a substantially lower level.
Furthermore, when the share price is within this distribution, it can be regarded as being
broadly in line with expectations even when fluctuating by around plus or minus one
standard deviation.
17
However, it is very difficult actually to draw up the diagram, make the tornado chart, gain an
understanding of the important risk factors, and then forecast earnings. I think that the
following model is useful for carrying out these operations with the least trouble. When
drawing up the diagram to provide the factor breakdown for earnings, it can be assumed
that the factors will be the same to some extent for business operations with the same
operational base, even if they belong to different corporate groups. At least for businesses
with their operational bases in Japan, they will be subject to the same Japanese
macroeconomic effects. As such, if the common factors causing earnings fluctuations can
be pinpointed for relatively pure business units, the business risk structure can be analyzed
using formula (2) in Exhibit 8.
The general-purpose model A introduced below is made up of inherent public risk for very
pure business units and private risk that largely reflects the relationship with competing
companies. Identification of the common risk factors reflecting the industrial sector’s
conditions enables not only easy appraisal of the company’s own risk but also appraisal of
rival companies in the same sector. A company can thereby understand its own strengths
and weaknesses and gain useful information related to M&A activities.
17. Business risk models based on common risk factors
17
Business risk models based on common risk factors
Category Meaning Factor Directivity Priority
Industrial production index + 1
% of Industrial production index + 1
Macro price Corporate price index 1
10y government bond yield 1
% of 10y government bond yield 1
Currendy % of currency rate($/\) 1
Semimacro
(S)
Industrial semimacro NINDS Semimacro index + 2
Human resources Number of employee + 3
Investment % of Total assets + 3
Predominancy in industry Share of Total assets + 3
Time lag Fundamental momentum Prior period Sales 4
Macro production quantity
Long term interesting rate
Macro
(M)
Private
(P)
Category Meaning Factor Directivity Priority
Macro production quantity % of Industrial production index + 1
Long term interesting rate 10y government bond yield 1
Currency % of currency rate($/\) 1
Industrial semimacro NINDS Semimacro index + 2
NINDS Number of companies + 2
NINDS Number of companies^2 - 2
Vertical integration Value added/Sales ratio + 3
Predominancy in industry Share of Total assets + 3
Fixed cost ratio SGA/Sales ratio - 3
Investment Depreciation expense 3
Financial leverage Debt/Total assets 3
Time lag Fundamental momentum Prior period Operating margin 4
Macro
(M)
Private
(P)
Semimacro
(S) Competition in industry
【S ales  risk model】
【Operating  margin risk model】
【Viewpoint of factor selection】
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
S ource: Nomura S ecurities  C o. Ltd, Tokyo
Operating profit
Cost rate
Quantity sold Price
Share
[Political]
・Regulation
・Taxation system
R&D
ContractPatent
Investment
Finance
[Economic]
・Economic trend
・Inflation
・Currency rates
・Interest rates
[Social]
・Population
・Life level
Maturity
[Technology]
・Innovation
Regulation
Personnel Blanding strategy
P/L
Private RiskPublic Risk
Semi-macroeconomics
Macroeconomics(Domestic, Global)
Sales
Ordinary course
of business
Economic trend
in industry
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 17 shows the most basic general-purpose model for assessing operating profit risk.
This is composed of a sales risk assessment model and an operating margin risk
assessment model, with operating profit risk being assessed as the product of these two
elements. The various types of risk are assessed by means of the common factors
identified from the relationship between public risk and private risk, with assistance from the
diagram described earlier.
18
18. Business risk models~65 different industry ①
18
Business risk models~65 different industry ①
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
Total M S P L M S P L Total M S P L M S P L
1 Chemicals 1 Glass & Cement 0.71 7 3 1 2 1 29% 13% 19% 39% 0.73 7 2 0 4 1 8% 0% 82% 10%
2 Synthetic Fibers 0.76 6 2 1 2 1 18% 13% 17% 52% 0.81 6 2 0 3 1 8% 0% 73% 19%
3 Natural Fibers 0.76 5 3 0 1 1 37% 0% 15% 48% 0.84 5 2 0 2 1 11% 0% 56% 33%
4 Paper & Pulp 0.77 4 2 0 1 1 34% 0% 27% 40% 0.84 7 1 1 4 1 4% 4% 80% 12%
5 Oil 0.77 7 3 1 2 1 17% 17% 19% 47% 0.92 6 0 1 4 1 0% 6% 52% 42%
6 Diversified Chemicals 0.95 6 2 1 2 1 19% 37% 18% 26% 0.74 6 1 0 4 1 5% 0% 93% 3%
7 Fine Chemicals 0.78 8 3 1 3 1 25% 11% 15% 48% 0.71 8 3 0 4 1 13% 0% 64% 23%
8 Electronic Materials 0.77 4 1 1 1 1 30% 16% 9% 45% 0.77 7 2 0 4 1 12% 0% 87% 1%
2 Steel 9 Steel 0.78 3 2 0 0 1 48% 0% 0% 52% 0.72 5 2 0 2 1 32% 0% 17% 51%
& Non-Ferrous Metals 10 Specialty Steels & Other Metal Products 0.71 6 3 0 2 1 33% 0% 18% 49% 0.81 8 2 1 4 1 7% 2% 81% 10%
11 Non-Ferrous Metals 0.76 5 2 1 1 1 38% 9% 9% 45% 0.75 6 3 0 2 1 20% 0% 73% 7%
12 Wire & Cables 0.84 6 2 1 2 1 31% 12% 15% 43% 0.79 4 1 0 2 1 8% 0% 87% 5%
3 Machinery 13 Environmental Equipment & Plant 0.67 6 2 1 2 1 19% 12% 23% 46% 0.78 7 1 1 4 1 6% 4% 85% 6%
14 Construction Machinery 0.77 7 2 1 3 1 16% 14% 32% 38% 0.78 7 1 1 4 1 3% 2% 88% 6%
15 Machine Tools 0.77 7 3 1 2 1 31% 15% 21% 33% 0.85 7 3 0 3 1 15% 0% 81% 4%
16 Bearings & Tools 0.87 6 3 1 1 1 31% 17% 8% 45% 0.85 5 1 1 2 1 17% 8% 43% 32%
17 Robots & Pneumatic Machinery 0.68 4 2 0 1 1 51% 0% 20% 29% 0.95 4 0 1 2 1 0% 5% 90% 6%
18 Other Industrial Machinery 0.72 10 5 1 3 1 31% 11% 24% 34% 0.87 7 3 0 3 1 7% 0% 83% 10%
19 Shipbuilding & Heavy Machinery 0.67 4 1 0 2 1 16% 0% 38% 45% 0.76 4 1 0 2 1 5% 0% 87% 8%
4 Automobiles 20 Automobiles 0.88 5 2 1 1 1 19% 22% 18% 41% 0.81 5 2 0 2 1 7% 0% 75% 18%
21 Auto Parts 0.82 7 2 1 3 1 23% 17% 18% 42% 0.80 7 2 1 3 1 11% 3% 60% 27%
22 Tires 0.86 4 3 0 0 1 55% 0% 0% 45% 0.85 2 0 0 1 1 0% 0% 53% 47%
5 Electrical Machinery 23 Industrial_Electronics 0.74 6 2 1 2 1 31% 13% 17% 40% 0.78 6 2 0 3 1 7% 0% 88% 5%
& Precision Equipment 24 Telecommunications Equipment 0.74 5 2 0 2 1 17% 0% 42% 42% 0.79 6 1 0 4 1 4% 0% 92% 4%
25 Consumer Electronics 0.83 7 4 0 2 1 34% 0% 12% 54% 0.75 7 3 0 3 1 10% 0% 83% 7%
26 Electronic Devices 0.74 9 5 0 3 1 40% 0% 22% 37% 0.86 7 2 0 4 1 8% 0% 83% 9%
27 Semiconductor Manufacturing Equipment 0.81 6 3 1 1 1 41% 19% 14% 27% 0.89 7 1 1 4 1 4% 5% 89% 2%
28 Precision Equipment & Films 0.76 5 2 0 2 1 19% 0% 33% 48% 0.88 4 0 0 3 1 0% 0% 97% 3%
29 Other Industrial Electronics 0.63 9 4 1 3 1 39% 18% 16% 27% 0.86 8 2 0 5 1 4% 0% 91% 5%
Weight of risk
Operating Margin Risk model
Number of factor Weight of risk
Sales Risk Model
R^2
Number of factor
R^2
Industries(NINDM) Industries(NINDS)
Source: Nomura Securities Co., Ltd. Tokyo
19. Business risk models~ 65 different industry ②
19
Business risk models~ 65 different industry ②
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
Total M S P L M S P L Total M S P L M S P L
6 Pharmaceuticals 30 Pharmaceuticals 0.73 5 2 1 1 1 14% 20% 20% 46% 0.87 6 1 0 4 1 2% 0% 77% 21%
& Health Care 31 Health Care 0.71 4 1 1 1 1 9% 29% 40% 21% 0.92 5 0 0 4 1 0% 0% 85% 15%
7 Food Products 32 Basic Foods 0.68 6 2 0 3 1 16% 0% 19% 65% 0.86 8 2 1 4 1 3% 2% 85% 10%
33 Processed Foods 0.68 5 2 0 2 1 17% 0% 20% 63% 0.81 6 2 0 3 1 3% 0% 79% 18%
34 Liquors & Beverages & Tobacco 0.66 3 1 0 1 1 15% 0% 21% 64% 0.85 4 0 0 3 1 0% 0% 34% 66%
8 Household Goods 36 Cosmetics & Toiletries 0.50 1 0 0 0 1 0% 0% 0% 100% 0.91 4 1 0 2 1 3% 0% 74% 24%
37 Apparel & Sports Goods 0.87 6 3 0 2 1 26% 0% 12% 62% 0.68 6 2 0 3 1 6% 0% 80% 13%
38 Other Personal Goods 0.82 8 4 0 3 1 31% 0% 24% 45% 0.93 5 1 0 3 1 2% 0% 74% 24%
9 Trading Companies 39 Trading Companies 0.63 6 3 0 2 1 40% 0% 21% 39% 0.83 5 1 0 3 1 12% 0% 28% 60%
10 Retailing 40 Department Stores 0.84 5 3 0 1 1 30% 0% 14% 56% 0.84 4 0 0 3 1 0% 0% 85% 15%
41 Specialty Retailers 0.64 6 2 0 3 1 17% 0% 41% 43% 0.72 4 0 0 3 1 0% 0% 87% 13%
42 General Merchandise Stores & Convenience Stores 0.72 4 1 0 2 1 7% 0% 35% 58% 0.96 5 0 0 4 1 0% 0% 92% 8%
11 Services 44 Restaurants 0.73 4 1 0 2 1 6% 0% 49% 45% 0.79 5 0 0 4 1 0% 0% 88% 12%
45 Consumer Services 0.68 4 2 0 1 1 19% 0% 40% 41% 0.79 3 0 0 2 1 0% 0% 61% 39%
46 Business Services 0.70 6 3 1 1 1 39% 15% 15% 30% 0.84 7 2 0 4 1 6% 0% 75% 19%
12 Software 47 Consumer Software and Games 0.39 2 0 0 1 1 0% 0% 74% 26% 0.72 3 1 0 1 1 12% 0% 58% 30%
48 Business Software 0.77 6 3 0 2 1 44% 0% 19% 37% 0.87 6 2 0 3 1 5% 0% 88% 7%
13 Media 49 Cinemas and Leisure Facilities 0.64 2 0 0 1 1 0% 0% 12% 88% 0.84 6 1 0 4 1 5% 0% 63% 31%
50 Broadcasting 0.68 6 4 0 1 1 81% 0% 9% 9% 0.88 5 0 0 4 1 0% 0% 93% 7%
51 Publishing & Advertising 0.62 3 1 0 1 1 32% 0% 40% 28% 0.85 5 0 0 4 1 0% 0% 99% 1%
14 Telecommunications 53 Telecommunications Providers & Internet Sevices 0.70 5 1 1 2 1 12% 21% 40% 27% 0.68 3 0 0 2 1 0% 0% 89% 11%
15 Construction 54 Major General Contractors 0.94 4 0 1 2 1 0% 54% 21% 25% 0.55 4 1 0 2 1 24% 0% 68% 8%
& Engineering 55 Other General Contractors 0.83 6 3 0 2 1 26% 0% 32% 42% 0.80 8 2 1 4 1 5% 2% 76% 17%
56 Road Pavers 0.89 6 2 1 2 1 11% 16% 26% 48% 0.94 5 0 0 4 1 0% 0% 94% 6%
57 Building Installation Works 0.83 7 4 0 2 1 34% 0% 18% 49% 0.86 6 0 1 4 1 0% 3% 79% 18%
16 Housing & Real Estate 58 Housing 0.67 8 4 1 2 1 32% 19% 19% 29% 0.85 5 2 0 2 1 7% 0% 80% 14%
59 Real Estate 0.58 5 1 1 2 1 10% 14% 18% 57% 0.95 4 1 0 2 1 6% 0% 51% 43%
60 Housing Materials 0.79 8 3 1 3 1 25% 6% 25% 44% 0.81 5 2 0 2 1 8% 0% 59% 33%
17 Transportation 61 Marine Transpotation 0.72 6 3 0 2 1 36% 0% 16% 49% 0.67 5 0 0 4 1 0% 0% 78% 22%
62 Air Transportation 0.96 4 1 1 1 1 15% 33% 31% 21% 0.75 4 2 0 1 1 56% 0% 16% 28%
63 Trucking 0.63 5 2 1 1 1 30% 24% 11% 35% 0.83 2 1 0 0 1 11% 0% 0% 89%
64 Railways 0.65 4 1 0 2 1 13% 0% 37% 50% 0.83 2 1 0 0 1 8% 0% 0% 92%
65 Harbor Transportation & Warehouses 0.80 7 3 1 2 1 24% 18% 15% 43% 0.81 4 1 0 2 1 5% 0% 50% 45%
18 Utilities 66 Electricity 0.96 4 2 1 0 1 22% 33% 0% 45% 0.70 1 0 0 0 1 0% 0% 0% 100%
67 Gas 0.97 6 2 1 2 1 9% 31% 12% 48% 0.67 3 1 0 1 1 22% 0% 16% 62%
Sales Risk Model Operating Margin Risk model
Number of factor Weight of riskIndustries(NINDM) Industries(NINDS)
R^2
Number of factor Weight of risk
R^2
Source: Nomura Securities Co., Ltd. Tokyo
When constructing the business risk model, it is important to model the risk structure using
the smallest business units possible. Exhibits 18 and 19 show a business risk model based
on 65 different sectors. These exhibits show that nearly all of the models achieve 70% or
19
higher and thus have relatively high explanatory power. The advantage of this factor model
is that it reveals the risk structure of the business in question. This demonstrates that the
risk structure varies quite a bit between different sectors.
20. Business risk models~Comparison of risk weight①
20
Business risk models~Comparison of risk weight①
【Weight of risk of Sales risk model】 【 Weight of risk of Operating margin risk model】
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, TokyoS ource: Nomura S ecurities  C o. Ltd, Tokyo
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Glass & Cement
Synthetic Fibers
Natural Fibers
Paper & Pulp
Oil
Diversified Chemicals
Fine Chemicals
Electronic Materials
Steel
Specialty Steels & Other Metal Products
Non-Ferrous Metals
Wire & Cables
Macro Semimacro Private Time lag(prior period sales)
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Glass & Cement
Synthetic Fibers
Natural Fibers
Paper & Pulp
Oil
Diversified Chemicals
Fine Chemicals
Electronic Materials
Steel
Specialty Steels & Other Metal Products
Non-Ferrous Metals
Wire & Cables
Macro Semimacro Private Time lag(prior period operating margin)
Source: Nomura Securities Co., Ltd. Tokyo
For example, Exhibit 20 includes the steel sector, for which macroeconomic factors are
relatively important. Stated differently, the model suggests that the steel sector is sensitive
to economic trends. As such, misreading of the economic outlook has a major impact on
earnings and when the economic outlook is uncertain companies must therefore raise their
estimation of risk from earnings fluctuations when formulating their business strategies. In
overall terms, half of sales variation depends on the size of sales in the previous year. Sales
are at the top of the profit and loss statement and thus do not to vary that much each year,
unless the sector as a whole undergoes major structural changes or the company in
question itself carries out major restructuring. Turning to factors other than the previous
year's sales, public risk (macro and semi macroeconomics factors) makes up around half of
the remainder. Public risk cannot really be controlled by individual companies, although
some risks can be hedged via the capital markets and management can consider hedging
measures based on the size of risk and the costs involved. In contrast, it is striking how
private risk has such a high weighting with regard to the operating margin. Private risk can
be controlled by the company on its own and management should decide on strategy based
on this risk.
20
21. Business risk models~Comparison of risk weight ②
21
Business risk models~Comparison of risk weight ②
【Weight of risk of Sales risk model】 【 Weight of risk of Operating margin risk model】
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, TokyoS ource: Nomura S ecurities  C o. Ltd, Tokyo
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Environmental Equipment & Plant
Construction Machinery
Machine Tools
Bearings & Tools
Robots & Pneumatic Machinery
Other Industrial Machinery
Shipbuilding & Heavy Machinery
Automobiles
Auto Parts
Tires
Industrial_Electronics
Telecommunications Equipment
Consumer Electronics
Electronic Devices
Semiconductor Manufacturing Equipment
Precision Equipment & Films
Other Industrial Electronics
Macro Semimacro Private Time lag(prior period sales)
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Environmental Equipment & Plant
Construction Machinery
Machine Tools
Bearings & Tools
Robots & Pneumatic Machinery
Other Industrial Machinery
Shipbuilding & Heavy Machinery
Automobiles
Auto Parts
Tires
Industrial_Electronics
Telecommunications Equipment
Consumer Electronics
Electronic Devices
Semiconductor Manufacturing Equipment
Precision Equipment & Films
Other Industrial Electronics
Macro Semimacro Private Time lag(prior period operating margin)
Source: Nomura Securities Co., Ltd. Tokyo
22. Business risk models for Electronics
22
Business risk models for Electronics
鉱工業生産伸
び率
15%
円ドルレート変
化率
5%
売上高付加価
値率
35%
販管費比率
23%
減価償却費(対
数)
10%
前期売上高営
業利益率
12%
鉱工業生産
14%
10年国債応募者利
回り前年差
3%
従業員数(基準化)
7%
前期売上高(基準
化)
62%
鉱工業生産伸び率
14%
(Macro)
Industrial production index
14%
(Macro)
(プライベート)
(Momentum)
(マクロ)
(マクロ)
(プライベート)
(プライベート)
(モメンタム)
(Macro)
% of Industrial
Production 14%
(Macro)
% of 10y government
bond yield 3%
(Private)
# of Employees
(normalization) 7%
t Prior period
Sales 62%
(Macro)
% of currency rate
5%
(Macro)
% of Industrial
Production 15%
(Private)
Value added/Sales
35%
(Private)
SGA/Sales ratio
23%
(Momentum)
Prior period
Operating margin
12%
(Private)
Depreciation expense
10%
[ Chapter 2. The quantification of business risk ]
Sales risk model Operating margin risk model
Type Factor T value Type Factor T value
M Industrial production index 6.93 M 2 M % of Industrial production index 9.67
M % of Industrial production index 8.41 M 6 M % of currency rate ($/\) 3.35
M % of 10y government bond -2.23 P 5 P Value added/Sales 11.10
P # of employees(normalization) 2.80 P 6 P SGA/Sales ratio -8.21
L Prior period sales(normalization) 24.26 P 7 P Depreciation expense(log) -4.77
Intercept -6.78 L 2 L Prior period Operating margin 6.62
R^2 0.95 Intercept 3.15
R^2 0.84
Operating
profit
Source: Nomura Securities Co., Ltd. Tokyo
In order to understand the above points in more detail, Exhibit 22 shows an actual appraisal
example using a risk model for the electronics industry. I have used Hitachi's consolidated
accounts for the example, since only public data can be used, and appraised each
21
individual business unit separately before adding them together in a bottom-up fashion. In
the risk structure for sales, the previous year's sales make up 60% of the total, with
macroeconomic factors making up 30% and the model having 95% explanatory power. The
overall risk structure for the operating margin is 70% private risk and 20% macroeconomic
factors. In order to reduce operating profit risk and increase returns in the electronics
business, it is therefore important in terms of risk management to adopt a strategy of
controlling private risk for the operating margin. Use of this model to estimate Hitachi’s
sales and operating profits over the past 22 years results in a correlation of at least 0.98
and the model is thus very effective in terms of absolute levels.
23. Business risk models for Electronics~Breaking down changes in sales by risk factors and impact on
sales(Hitachi)
23
-1,500,000
-1,000,000
-500,000
0
500,000
1,000,000
1,500,000
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
C
ha n ge s i n S
a le s( m ill
io n ye n )
Industrial production % of Industrial production % of Prior period Total assets
Employees(normalization) Prior period sales(normalization) Residuals
changes in Sales
Business risk models for Electronics~Breaking down changes in
sales by risk factors and impact on sales(Hitachi)
【Breaking  down changes  in sales  by ris k factors】 【Impact on sales  by risk factors】
• Number in ( ) is 1σ of data for the past 20 years.
• The amount of influence which change of 1σ of
each risk factor gives to sales.
• The sales of Hitachi are greatly affected by
economic fluctuation.
Change of sales for 1σ change of each factor
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
S ource: Nomura S ecurities  C o. Ltd, Tokyo
48,543 (5.6)
441,840 (4.59%)
95,138 (8.19%)
111,015 (63,512)
366,031
(1,364,108)
0 100,000 200,000 300,000 400,000 500,000
Industrial production
% of Industrial production
% of Prior period Total
assets
Employees(normalization)
Prior period
sales(normalization)
(million yen)
(Fiscal year)
Source: Nomura Securities Co., Ltd. Tokyo
Next, it is also possible to identify the risk factor that has the greatest impact on sales and
its size by breaking down changes in sales over time by risk factor (Exhibit 23). Based on
my calculations, economic trends have the most impact on Hitachi's sales, with, for example,
fluctuation by plus or minus one standard deviation, or 4.6% in the industrial production
index, having a sales impact of plus or minus ¥440bn. Stated differently, economic
fluctuations within the expected range result in sales fluctuations of ¥440bn at Hitachi. This
equates to an impact of just over 4% based on Hitachi's current sales of around ¥10trn.
22
24. Business risk models for Electronics~Breaking down changes in operating margin by risk factors and
impact on operating margin (Hitachi)
24
Business risk models for Electronics~Breaking down changes in
operating margin by risk factors and impact on operating margin(Hitachi)
(年度)
[ Chapter 2. The quantification of business risk ]
S ource: Nomura S ecurities  C o. Ltd, Tokyo
S ource: Nomura S ecurities  C o. Ltd, Tokyo
8.92%
6.12%
4.43% 5.04%
6.77% 7.08% 6.55%
4.53%
2.95% 2.88%
4.01% 4.09% 3.49%
2.48%
-0.43%
2.18%
4.07%
1.87% 2.14%
3.09% 2.70%
-1.47%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
O
pe ra ti ng m ar gi n % of Industrial production Value added/Sales SGA/Sales ratio Depreciation expense(log)
Prior period Operating margin Residuals Operating margin
0.60% (2.45%)
0.10% (0.2)
0.90% (2.06%)
1.50% (3.2%)
0.80% (4.48%)
0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6%
% of Industrial
production
Value added/Sales
SGA/Sales ratio
Depreciation expense
(log)
Prior period Operating
margin
Change of operating margin for 1σ change of each factor
(Fiscal year)
【Breaking  down Operating  margin by risk factors】 【Impact on operating  margin by risk factors】
• Number in ( ) is 1σ of data for the past 22 years.
• The amount of influence which change of 1σ of
each risk factor gives to operating margin.
• The operating margin of Hitachi are greatly affected
by added value/sales factor.
* Added value/Sales = [Board members’ bonus + Salary + Rental
+ Depreciation cost + Tax + Interest payable + Ordinary profit]
/ Sales
Source: Nomura Securities Co., Ltd. Tokyo
The same kind of analysis is possible with the operating margin (Exhibit 24). After once
more identifying the principal risk factors, the earnings forecast distribution can be simply
estimated considering multiple risk factors by making forecasts as explained earlier using a
range of plus or minus one standard deviation, or the range between management’s
optimistic scenario and its pessimistic scenario. By making such estimates for each
business unit, it is possible to judge objectively how aggressive management plans are for
each business unit and to identify which are most sensitive to fluctuations in interest rates
or exchange rates and roughly what values are involved.
The factor model is also effective for residual analysis. If an anomaly can be spotted in
residuals that cannot be estimated using common factors alone, it can be used as
investment information.
23
III. From business risk assessment to company risk
management
25. Business portfolio assessment
25
Business portfolio assessment
ポートフォリオ理論による事業部門評価(1999年度~2003年度の平均値)
-40%
-20%
0%
20%
40%
60%
80%
100%
0% 10% 20% 30% 40% 50% 60% 70%
事業リスク(EP/投下資本の標準偏差)







E
P
/









D
F
G
M
I
E
L
K J
H
B
N
C
A
Rationalizing
Restructuring, Withdrawal
Core business units
Target of M&A
B is an business unit effective for
making the optimal business portfolio
of the whole group upper left direction.
is a si ss it ff tiv f r
aki g t ti al b si ess rtf li
f t l gr u up er l ft ir ti .
Spin-out, IPO
Strategic business units
Reduction of risk
Business risk
E
xp e ct e d r et u rn S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 3. From business risk assessment to company risk management ]
Source: Nomura Securities Co., Ltd. Tokyo
When business risk assessment is applied to the entire group’s risk management, it is
important that managers adopt a viewpoint covering the entire portfolio and much depends
on the decisions made regarding the concepts of risk appetite and risk tolerances. Risk
appetite can be expressed via the production of a risk map, the improvement of which
results in a portfolio strategy. As a result of taking steps to cope with risk, managers can
understand how far the risk will fall in response to business value expectations rising by a
certain degree. After the various business units each carry out this work, a portfolio
assessment such as the one shown in Exhibit 25 can be drawn up. The horizontal axis in
this exhibit is residual risk. Furthermore, the size of the circles represents the expected
value of each business unit after adopting measures against risk. This process helps with
the identification of core operations where business resources should be concentrated at
the so-called efficient frontier, the low-risk and low-return businesses that are candidates for
rationalization, and the operations with negative expected returns where withdrawal is the
best option.
24
26. Optimal risk hedge strategy
26
Optimal risk hedge strategy
Optimal risk hedge strategy
by hedge + risk allocation
S
tock price 
risk
B
usiness riskC
redit risk
Measurement of total riskr t f t t l ri
C
urrency 
risk
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 3. From business risk assessment to company risk management ]
Risk in different units may be within the risk tolerances of the individual units, but, taken together, risks might exceed
the risk appetite of the entity as a whole, in which case additional or different risk response is needed to bring risk
within the entity’s risk appetite.
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 26 illustrates the concept of risk allocation. Although individual business units may
be within the range of risk appetite, the aggregate of such risk could be more than the level
of risk appetite sought by the overall group. In such a case, additional measures or other
measures to counter risk would be required to rein in the risk level. In this way managers
achieve risk management by understanding and appraising the mutual relationship with risk.
25
27. Optimal business portfolio and business capital allocation
27
-15%
0%
15%
30%
45%
0% 2% 4% 6% 8% 10% 12%
EPOC(=EP/投下資本)の標準偏差(1999年度~2006年度)
E
P
O
C
(=
E
P
/




)の




1
9
9
9



2
0
0
6



部門1
部門5
部門3
部門2
部門4 部門6
部門8
部門9
部門10
部門11
部門7
Optimal business portfolio and business capital allocation
Whole company
リスク






Risk
E
xpe
c te d re
tu rn S ource: Nomura S ecurities  C o. Ltd, Tokyo
BU1
BU2
BU3
BU4
BU5
BU6
BU7 BU8
BU9
BU10
BU1
[ Chapter 3. From business risk assessment to company risk management ]
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 27 shows the efficient frontier of a particular company, with the curve showing the
company’s most suitable business portfolio. Managers can use the results of the analysis to
compare the expected returns for each individual business unit with the level of risk appetite
sought by the overall group and then allocate business resources accordingly.
26
28. The view of risk management and risk capital
28
The view of risk management and risk capital
Accepting
C over
with capital
Likelihood
Loss
E xceed risk appetite level
S teady risk
Unsteady risk
R isk appetite  level (It assumes  in advance 
in the capital market)
R isk capital
Bankruptcy
Legal risk
Earthquake
Business risk An unprecedented
natural disaster etc.
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 3. From business risk assessment to company risk management ]
Source: Nomura Securities Co., Ltd. Tokyo
The model introduced above is for business risk, but companies also shoulder crisis risk
(Exhibit 28). This is easy to quantify relatively and hedging via markets is also possible. The
correct response to the likes of earthquake risk or risk of business counterparties going
bankrupt is to accumulate the level of risk capital deemed appropriate by management.
Furthermore, once estimated it is not necessary to adjust frequently the assessment of
crisis risk.
27
IV. Example of using the business risk assessment model as
investment information
This section shows the results of analysis regarding the relationship between models and
stock price performance.
The main points of the simulation carried out are as follows. I focused on the model
residuals (actual values minus model estimates) from the business risk assessment model
(sales risk model) and then analyzed the relationship with stock price performance (excess
returns against the TOPIX).
The underlying hypothesis is as follows. The model residuals are the values affecting sales
after factor adjustment and if these are large positive values the actual performance is in
excess of the normally expected range. As such, I would expect the stock price
performance of such stocks to be strong. Furthermore, I would expect stocks with model
residuals on an upward trend to achieve strong stock price performances in the future.
29. The model universe and industry composition
29
The model universe and industry composition
[ Chapter 4. Example of using the business risk assessment model as investment information ]
17%
13%
12%
8% 8%
7% 7% 6%
5% 5%
3% 3% 2% 2% 1% 1% 1%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
C
h e m ic al s E
le c tr ic al M
ac h in e ry &
P
re c is io n E
qu ip m e n t M
ac h in e ry C
o n st ru c ti o n &
E
n gi n e e ri n g A
u to m o bi le s T
ra n sp o rt at io n S
te e l &
N
o n -
F
e rr o u s M
e ta ls F
o o d P
ro du c ts H
o u se h o ld G
o o ds H
o u si n g &
R
e al E
st at e S
e rv ic e s P
h ar m ac e u ti c al s &
H
e al th C
ar e R
e ta ili
n g T
ra di n g C
o m pa n ie s U
ti lit
ie s M
e di a S
o ft w ar e ra ti o o f sa m pl e c o m po si ti o n 0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
c u m u la ti ve r at io o f sa m pl e c o m po si ti o n n. of company
1 Chemicals 173
2 Steel & Non-Ferrous Metals 70
3 Machinery 126
4 Automobiles 81
5 Electrical Machinery & Precision Equipment 128
6 Pharmaceuticals & Health Care 27
7 Food Products 65
8 Household Goods 54
9 Trading Companies 19
10 Retailing 20
11 Services 27
12 Software 5
13 Media 11
15 Construction & Engineering 85
16 Housing & Real Estate 51
17 Transportation 70
18 Utilities 13
1,025total
NINDM
S ource: Nomura S ecurities  C o. Ltd, Tokyo
Source: Nomura Securities Co., Ltd. Tokyo
The model universe is 1,025 companies that were continuously listed for the 20 years
between FY86 and FY05. The heavily represented sectors include chemicals, electrical &
precision equipment, and machinery, while the likes of recently listed IT companies are few
in number (Exhibit 29).
28
30. The model residual vs. Stock price performance~Single factor regression
30
The model residual vs. Stock price performance~Single factor regression
The relationship between model residuals and stock price performance by means of simple regression analysis.
This shows that the relationship between stock price performance and model residuals is generally significant for
both fiscal years and industry sectors.
fiscal year coeff. t-stat. R^2 n. of sample
1986 19% 3.81 0.03 565
1987 12% 1.56 0.00 579
1988 14% 2.89 0.01 596
1989 14% 4.18 0.02 999
1990 5% 3.10 0.01 1,025
1991 8% 4.63 0.02 1,025
1992 10% 7.85 0.06 1,025
1993 15% 8.39 0.06 1,025
1994 15% 6.57 0.04 1,025
1995 12% 5.18 0.03 1,025
1996 3% 1.04 0.00 1,025
1997 18% 8.87 0.07 1,025
1998 13% 5.85 0.03 1,025
1999 25% 5.94 0.03 1,025
2000 13% 5.36 0.03 1,025
2001 15% 5.74 0.03 1,025
2002 16% 7.21 0.05 1,025
2003 33% 5.71 0.03 1,025
2004 14% 4.65 0.02 1,025
2005 14% 4.23 0.02 1,025
coeff. t-stat. R^2 n.of sample
1 Chemicals 10% 6.40 0.01 3,240
2 Steel & Non-Ferrous Metals 32% 11.90 0.10 1,295
3 Machinery 20% 10.67 0.05 2,310
4 Automobiles 19% 4.85 0.02 1,497
5 Electrical Machinery & Precision Equipment 19% 9.54 0.04 2,468
6 Pharmaceuticals & Health Care 11% 2.91 0.02 486
7 Food Products 3% 1.50 0.00 1,224
8 Household Goods 20% 5.35 0.03 1,006
9 Trading Companies 21% 4.68 0.06 353
10 Retailing -3% -0.27 0.00 376
11 Services 8% 1.53 0.00 500
12 Software 86% 3.39 0.11 97
13 Media 0% 0.07 0.00 211
15 Construction & Engineering 14% 5.10 0.02 1,547
16 Housing & Real Estate 11% 2.95 0.01 944
17 Transportation 8% 2.30 0.00 1,346
18 Utilities 9% 1.14 0.01 239
NINDM
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 30 looks at the relationship between model residuals and stock price performance
by means of simple regression analysis. This shows that the relationship between stock
price performance and model residuals is generally significant for both fiscal years and
industry sectors.
31. The model residual vs. Stock price performance~Multifactor regression
31
The model residual vs. Stock price performance~Multifactor regression
(Note) t-statistics in the above table.
Tobin q = (Market value + Debt)/Total assets
Financial leverage = Debt/Total assets

O O O O O
① idiosyncratic residual 21.1 21.2 21.3 21.2 20.8
② PBR -1.7
③ ln(market cap.) -7.7 -6.9 -7.0 -6.2
④ tobin q -4.6 -2.3 -2.1 -3.9
⑤ ln(asset) -3.6
⑥ finaicial leverage 3.2 3.3 2.6 2.7 5.7
⑦ sector dummy
Chemicals 1.3 1.8
Steel & Non-Ferrous Metals 2.5 3.3
Machinery 1.9 2.8
Automobiles 2.7 3.6
Electrical Machinery & Precision Equipment 2.2 2.9
Pharmaceuticals & Health Care 1.3 2.2
Food Products 0.6 1.2
Household Goods 1.4 2.0
Trading Companies 0.9 1.4
Retailing 2.0 2.6
Services 0.6 1.2
Software 3.7 4.1
Media 0.6 1.3
Construction & Engineering 0.4 1.2
Housing & Real Estate 1.3 1.8
Transportation 1.2 1.4
⑧ intercept 8.9 5.6 8.9 3.8 2.9
18,112 17,636 17,636 17,636 17,636
1,025 1,021 1,021 1,021 1,021
0.03 0.03 0.03 0.03 0.21
Ⅳmodel Ⅰ Ⅱ Ⅲ
factors for regression
Total Panel Observations(n. of sample)
Cross-section included(n. of company)
R-squared
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
29
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 31 I used panel data for the universe between FY86 and FY05 and tested the
effectiveness of model residuals by carrying out multifactor regression simultaneously
covering the factors likely to influence model residuals and stock price performance. Stated
differently, I tested whether t statistics remained effective when using other factors and
confirmed that the relationship between stock price performance and model residuals was
significant for all of the models.
32. Definition of the model residual trend
32
y = -0.03 x + 0.15
R2 = 0.53
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
19
8
6
19
8
7
19
8
8
19
8
9
19
9
0
19
9
1
19
9
2
19
9
3
19
9
4
19
9
5
19
9
6
19
9
7
19
9
8
19
9
9
20
0
0
20
0
1
20
0
2
20
0
3
20
0
4
20
0
5
id io sy n c ra ti c r es id u a l y = 0.04 x - 0.38
R
2
= 0.44
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1
9
86
1
9
87
1
9
88
1
9
89
1
9
90
1
9
91
1
9
92
1
9
93
1
9
94
1
9
95
1
9
96
1
9
97
1
9
98
1
9
99
2
0
00
2
0
01
2
0
02
2
0
03
2
0
04
2
0
05
id io sy n c ra ti c r es id u a l I define the model residual trend over time within a company as following,
Definition of the model residual trend
Idio_trend=1.8%
Idio_trend=-1.6%
Idio_trend = Slope × R-squared
S ource: Nomura S ecurities  C o. Ltd, TokyoS ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 32, I define the model residual trend over time within a company. In this case, the
model residual trend (shown as “idio-trend” in the exhibit) is the product of the model
residual and its reliability, and it becomes larger with long-term, stable growth.
30
33. The model residual trend vs. Stock price performance~the past 10y
33
The model residual trend vs. Stock price performance~the past 10y
10Y
51%
41%
22% 20%
1%
-23%
-11% -11% -10%
-22%
0.47
0.36
0.23
0.17
0.01
-0.51
-0.17
-0.20
-0.16
-0.51
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
#1 #2 #3 #4 #5 #6 #7 #8 #9 #10
st o c k pe rf o rm an c e
A
ve .)
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
μ
/
σ

A
ve ./
st de v.
stock perfomance μ/σ
Ave.(μ) median stdev.(σ) n.of sample
#1 51% 28% 108% 103 0.47
#2 41% 4% 112% 103 0.36
#3 22% 0% 98% 103 0.23
#4 20% -12% 120% 103 0.17
#5 1% -23% 90% 103 0.01
#6 -23% -31% 45% 102 -0.51
#7 -11% -24% 61% 102 -0.17
#8 -11% -25% 57% 102 -0.20
#9 -10% -29% 61% 102 -0.16
#10 -22% -32% 43% 102 -0.51
stock performance
μ/σ
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 33, I calculated the model residual trend using data for the 10 years up to FY05,
divided up the data into 10 groups based on the size of the residual, and examined the
relationship with share price performance. I was able to confirm the relationship between
the model residual trend and share price performance.
34. The model residual trend vs. Stock price performance~the past 20y
34
The model residual trend vs. Stock price performance~the past 20y
20Y
141%
58%
23% 20% 1%
-10% -10% -11%
-44% -50%
0.67
0.33
0.18 0.15
0.00
-0.12 -0.10 -0.09
-0.68
-0.84
-100%
-50%
0%
50%
100%
150%
200%
#1 #2 #3 #4 #5 #6 #7 #8 #9 #10
st o c k pe rf o rm an c e
A
ve .)
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
μ
/
σ

A
ve ./
st de v.
stock perfomance μ/σ
Ave.(μ) median stdev.(σ) n.of sample
#1 141% 62% 209% 103 0.67
#2 58% -2% 176% 103 0.33
#3 23% -6% 129% 103 0.18
#4 20% -22% 128% 103 0.15
#5 1% -36% 115% 103 0.00
#6 -10% -33% 87% 102 -0.12
#7 -10% -28% 98% 102 -0.10
#8 -11% -43% 124% 102 -0.09
#9 -44% -59% 66% 102 -0.68
#10 -50% -59% 60% 102 -0.84
stock performance
μ/σ
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
31
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 34, I carried out the same process using data covering 20 years, confirming that
this relationship grows stronger as the period examined is lengthened.
35. The residual model trend vs. Future stock price performance(3y)
35
The residual model trend vs. Future stock price performance(3y)
The relationship between the model residual trend over the previous 10 years and stock price performance
over the next three years.
The relationship between stock price performance forecasts and the model residual trend is not stable.
The relation with the stock price performance over the next one year and five years are also same result.
Ave. 1995 1996 1997 1998 1999 2000 2001 2002 2003
#1 -12% -26% 10% 11% 36% 34% 73% 151% 39%
#2 -16% -49% 22% 6% 49% 33% 78% 163% 18%
#3 -18% -38% -5% -4% 35% 34% 71% 104% 45%
#4 -12% -30% -4% 3% 31% 63% 94% 222% 36%
#5 -22% -62% -10% -13% 29% 45% 68% 212% 30%
#6 -15% -65% -3% -13% 21% 39% 75% 179% 25%
#7 -21% -71% -13% -8% 24% 41% 85% 167% 41%
#8 -22% -62% -22% -7% 35% 39% 71% 128% 17%
#9 -18% -71% -6% -11% 36% 46% 89% 166% 3%
#10 -27% -73% -14% -14% 28% 35% 55% 167% 27%
correlation -0.73 -0.85 -0.76 -0.81 -0.47 0.13 -0.19 0.04 -0.47
median 1995 1996 1997 1998 1999 2000 2001 2002 2003
#1 -20% -55% -5% 5% 28% 16% 39% 32% 5%
#2 -26% -64% -12% -10% 34% 22% 40% 72% -9%
#3 -29% -68% -13% -10% 31% 24% 41% 69% 12%
#4 -25% -70% -22% -7% 23% 32% 40% 131% 1%
#5 -25% -72% -24% -19% 23% 26% 42% 147% 13%
#6 -25% -70% -19% -18% 19% 27% 51% 123% -2%
#7 -28% -78% -23% -18% 23% 26% 43% 78% 10%
#8 -31% -76% -29% -14% 26% 25% 44% 59% 5%
#9 -28% -76% -12% -13% 31% 30% 55% 63% -9%
#10 -31% -79% -26% -18% 24% 26% 29% 104% 4%
correlation 0.51 -0.92 -0.65 -0.70 -0.31 0.59 0.13 0.17 -0.09
-1.00
-0.80
-0.60
-0.40
-0.20
0.00
0.20
0.40
0.60
0.80
1995 1996 1997 1998 1999 2000 2001 2002 2003
c o rr e la ti o n
gr o u p n u m be r vs s to c k pe rf o rm an c e
ave. median
S ource: Nomura S ecurities  C o. Ltd, Tokyo
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 35 shows the relationship between the model residual trend over the previous 10
years and stock price performance over the next three years. This demonstrates that the
relationship between stock price performance forecasts and the model residual trend is not
stable.
32
36. Grouping simulation by the model residual trend and the model residual level
36
Grouping simulation by the model residual trend and the model residual level
The model residual trend = Slope × R-squared
The model residual level
(average for the past 3 periods)
I examined not only the simple residual trend but also the effectiveness of the model residual level.
The hypothesis in this case is that stocks with rising model residual trends and low residual levels (group
③ in the above table) will turn in strong stock price performances as their model residuals increase
positively.
Ave. upturn flat downturn
upper ① ④ ⑦
middle ② ⑤ ⑧
lower ③ ⑥ ⑨
trend
le ve l S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 36, I examined not only the simple residual trend but also the effectiveness of the
model residual level. The hypothesis in this case is that stocks with rising model residual
trends and low residual levels (group (3) in the exhibit 36) will turn in strong stock price
performances as their model residuals increase positively.
33
37. Grouping simulation by the model residual trend and the model residual level
~vs. Future stock price performance (3y)
37
upturn
flat
downturn
upper
millde
lower
0%
50%
100%
150%
200%
250%
300%
350%
stock performance
trend(idiosyncratic residual)
level(idiosyncratic
residual)
upturn
flat
downturn
upper
millde
lower
0%
50%
100%
150%
200%
250%
stock performance
trend(idiosyncratic residual)
level(idiosyncratic
residual)
Grouping simulation by the model residual trend and the model residual level
~vs. Future stock price performance(3y)
Average Median
Ave. upturn flat downturn
upper 91% 171% 38%
millde 207% 199% 103%
lower 332% 264% 178%
trend
le ve l median upturn flat downturn
upper 32% 91% 4%
millde 89% 117% 43%
lower 217% 173% 102%
trend
le ve l S ource: Nomura S ecurities  C o. Ltd, TokyoS ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 37, I took the model residual trend over the previous 10 years and the residual
level over the previous three years and compared it with the stock price performance over
the next three years. The results tie in with the hypothesis, in that stock price performance
tends to be higher for stocks with model residuals on a rising trend from a low level.
34
38. Grouping simulation by the model residual trend and the model residual level
~vs. Future stock price performance (3y), rolling
38
Grouping simulation by the model residual trend and the model residual level
~vs. Future stock price performance(3y), rolling
Average
Median
trend level 1995 1996 1997 1998 1999 2000 2001 2002 2003
upturn upper -18% -52% -9% -3% 38% 25% 55% 91% 35%
upturn middle -3% -30% 24% 13% 47% 48% 105% 207% 26%
upturn lower -18% -16% 42% 2% 39% 56% 142% 332% 79%
flat upper -21% -67% -23% -2% 26% 51% 71% 171% 52%
flat middle -13% -50% 1% -4% 26% 41% 75% 199% 33%
flat lower -25% -45% 1% -11% 22% 51% 100% 264% 21%
downturn upper -31% -77% -26% -16% 31% 27% 43% 38% -14%
downturn middle -23% -68% -16% -9% 32% 37% 62% 103% 21%
downturn lower -21% -68% -10% -12% 32% 47% 77% 178% 15%
trend level 1995 1996 1997 1998 1999 2000 2001 2002 2003
upturn upper -27% -67% -14% -12% 31% 15% 29% 32% 3%
upturn middle -22% -56% -5% 5% 31% 28% 69% 89% 7%
upturn lower -23% -55% -4% 4% 11% 40% 94% 217% 34%
flat upper -28% -76% -30% -18% 20% 30% 39% 91% 10%
flat middle -22% -71% -19% -8% 25% 23% 47% 117% 4%
flat lower -30% -72% -14% -20% 18% 34% 63% 173% 8%
downturn upper -34% -76% -32% -22% 23% 13% 34% 4% -23%
downturn middle -30% -78% -21% -13% 33% 30% 28% 43% 2%
downturn lower -28% -77% -23% -18% 27% 30% 53% 102% 0%
S ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
In Exhibit 38, I examine the stability of this relationship on a rolling basis. This exhibit shows
that in any fiscal year stocks with model residuals on a rising trend from a low level turn in
strong stock price performances.
35
39. Grouping simulation by the model residual trend and the model residual level
~vs. Future stock price performance (5y)
39
upturn
flat
downturn
upper
millde
lower
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
stock performance
trend(idiosyncratic residual)
level(idiosyncratic
residual)
upturn
flat
downturn
upper
millde
lower
0%
50%
100%
150%
200%
250%
stock performance
trend(idiosyncratic residual)
level(idiosyncratic
residual)
Grouping simulation by the model residual trend and the model residual level
~vs. Future stock price performance(5y)
中央値 上昇 ニュートラル 下降
上位 29% 17% 19%
中位 68% 51% 8%
下位 175% 66% 33%
トレンド



Average Median
Ave. upturn flat downturn
upper 84% 66% 50%
millde 210% 91% 80%
lower 242% 133% 82%
trend
le ve l S ource: Nomura S ecurities  C o. Ltd, TokyoS ource: Nomura S ecurities  C o. Ltd, Tokyo
[ Chapter 4. Example of using the business risk assessment model as investment information ]
Source: Nomura Securities Co., Ltd. Tokyo
Exhibit 39 carries out the same analysis for stock price performance over the next five years,
with the performance gap between different groups becoming clearer.
Conclusion
When making practical use of this model, it is difficult to reflect the risk factors particular to
pure individual business units by means of general-purpose model A for each sector. For
example, each business has its own particular common risk factors, such as the annual
recall volume for automakers or sales per unit of sales floor space for department stores. It
is possible to construct an original model for each company fairly easily by discounting such
common risk factors and then reflecting information on intellectual assets for the company
in question.
Japanese companies are currently engaged in complying with the Financial Instruments and
Exchange Law, but this only represents the foundations for full-fledged ERM and progress toward
becoming a value-creating company. Once this stage has been completed, it will become a question
of whether Japanese corporate managers have sufficient awareness and expertise to introduce ERM
in earnest. I think that companies that stop once they have completed their compliance with the
Financial Instruments and Exchange Law could be at risk of reducing their enterprise value. Once
compliance has been completed, companies should manage risk from a companywide viewpoint
using the most suitable and rational method, with the aim of raising enterprise value.

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