Dividends and Korea discount
The "three lows" ― low growth, low interest rates, and low returns ― are becoming a new norm worldwide.
In Europe, aggregate demand will not recover anytime soon due to the severity of sovereign debt problems and the rigors of austerity. In China, the tightening policy on the economy is loosening its grip, but it will be difficult to reverse slowing growth this year.
The faltering recovery in demand across Europe and Asia is putting a drag on global economic growth and prolonging low interest rates. Expectations are staying low for returns on equities, bonds, and commodities.
In this “three-lows” environment, global investors will be increasingly turning to dividend payouts. Especially since 2009, cash reserves at leading companies have been snowballing. Businesses are shying away from bold investments because of so much economic uncertainty as the global economy recovers at a slow pace. Growth in corporate profit is bound to weaken, compared to that in the past three years.
In the United States, dividend payouts will increase faster than corporate profits will in 2012. The Buffet tax on the wealthy, now the subject of debate across the world, is also strengthening the case for the government to encourage companies to pay more dividends by lowering tax rates on corporate income and raising tax rates on dividends.
The issue of dividends impacts stock market valuations. Historically, U.S. equities have been trading at 12-month forward price-earnings ratios higher than those of Korean equities ― specifically MSCI Korea.
According to Thomson Reuters, the Korean stock market's price-earnings ratio is 9.5, compared with the U.S. market's 13.
The dividend discount model of valuing a company based on the net present value of all future dividends suggests discount in the Korean market compared to the U.S. market should narrow because corporate profits grow faster at Korean companies than their U.S. counterparts. Nonetheless, in Korea, there is a culture against paying high dividends, especially bank dividends.
Fears of North Korea's provocations are rising in this election time in Korea, but geopolitical risks alone do not explain fully the so-called Korea discount.
The government's influence on corporate dividend policy may work against narrowing the discount in Korea's price-earnings ratio to that of the U.S. market by cancelling out Korea's growth premium over the U.S. Chances are that the price-earnings ratio gap between Korea and the United States will continue to go unresolved in 2012.
Daniel Cho is the head of research at Daishin Securities.