Why are major South Korean stocks persistently undervalued?
An electronic signboard at Seoul's Hana Bank shows the benchmark KOSPI closing at 2,496.63 points, Nov. 24, down 18.33 points or 0.73 percent from the previous session. Yonhap
Despite South Korea's remarkable economic progress over the past decades, major companies here are still grappling with the weight of the so-called Korea discount in the stock market, a phenomenon where their equities are undervalued compared to global peers.
Analysts now claim that the key culprits behind this unfavorable situation have shifted from geopolitical risks associated with North Korea’s military threats to structural problems, such as opaque corporate practices, ineffective regulations and unfriendly dividend policies.
They point out that non-transparent corporate practices primarily benefit a select few investors, notably the owners or largest shareholders, while regulations have failed to effectively curb these unfair practices, only restricting the returns of small investors.
Kim Kyu-shik, chairman of the Korean Corporate Governance Forum, which monitors transparent business management, argued that the leaders of family-controlled conglomerates are exploiting business strategies to “wield rights as controlling shareholders” without respecting small investors in a clear manner.
The practices addressed by Kim include corporate split offs and paid-in capital increases. Corporate split offs were often criticized for being misused by conglomerates as a means for overly aggressive business expansion, and in return, reduce the value of the parent company that initially attracted small investors to buy stocks.
Paid-in capital increases often led to concerns of lowered values of relevant stocks.
Kim pointed out the aforementioned strategies are exploited by both family owned and non-family owned businesses.
They include mid-sized underwear company BYC and Kakao, once a startup that grew into an internet giant.
“You can see ill-rooted practices live on over time across listed companies, thus hindering the stocks from being properly valued.”
Jung Eui-jung, head of the Korean Stockholders’ Alliance, said that geopolitical risks associated with North Korea's provocations are no longer the main factor for South Korean stocks' undervaluation.
“Does South Korea face a bigger, more imminent threat than Taiwan? I don’t think so. Yet, Seoul's stock market is more undervalued than Taipei’s,” said Jung. He was referring to Taiwan being dwarfed by China’s economic and military power in the midst of Beijing’s growing ambition to forcefully annex the self-ruled island.
South Korea is more than 50 times larger than North Korea in terms of gross domestic product (GDP). The South’s military is considered more robust than the North’s despite Pyongyang’s evolving nuclear and missile threats and asymmetric warfare tactics.
Under the circumstances, data from the Taiwan Stock Exchange (TWSE), the country’s main bourse, showed its price book-value ratio (PBR) has stood at around 2.0 for years, compared to Seoul’s benchmark KOSPI whose PBR was 0.92 on Nov. 24.
PBR is used to compare a company’s market price to its book value. A ratio below 1 means a firm’s stock price is less than the money it would get by selling all of its assets at book price.
As of Nov. 24, nearly 70 percent of the KOSPI's domestic stocks, except for preferred shares, had a PBR below 1.
Many large-cap KOSPI stocks were less appreciated in their value, including POSCO Holdings whose PBR stands at 0.68, Hyundai Motor at 0.45 and its sister company Kia at 0.86.
Korea's four largest banking groups also suffered from underestimated stock values.
The PBR of No. 1 market player, KB Financial Group, stood at 0.43, while its archrival Shinhan Financial Group stood at 0.39. The smaller players, Hana and Woori, remained at 0.33 and 0.32, respectively.
The PBR of market bellwether Samsung Electronics was at 1.24. It, however, was behind rival TSMC of Taiwan, whose ratio was at 4.89.
“The comparison between South Korea and Taiwan evidently shows that the Korea discount does not mainly stem from North Korea’s threats,” Jung said.
He also said that, considering South Korea is the world’s 13th largest economy, the KOSPI should have surpassed the 4,000 point mark already if it had not been negatively affected by the Korea discount.
The index broke the 1,000 mark in 2005, 2,000 in 2007 and 3,000 in 2021 – each for the first time – but has remained in the 2,000 range this year in the aftermath of the pandemic.
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In its recent report, titled "Korea's Next S-Curve," McKinsey & Company pointed out that Korea ranked ninth out of 12 Asian countries in an assessment by the Asian Corporate Governance Association in 2020. The rank remained unchanged from 2016 and 2018.
"This is mainly due to the assessment that dividends, rules on the composition of nomination committees for outside directors, and auditor appointment standards are below global ones," the company said.
In their joint move, the Korean Stockholders’ Alliance and the Korean Corporate Governance Forum are correspondingly calling on the government to revise Clause 3 under Article 382 of the Commercial Act.
They find the clause to be “most responsible for leaving the door open for businesses to be negligent in guaranteeing shareholders’ return.”
The clause stipulates that a company's board of directors, in accordance with the law and corporate articles, should faithfully carry out its duty on behalf of the company it serves. But the clause does not address its responsibility to shareholders.
The Korean Stockholders’ Alliance also finds that the regulation should be eased on capital gains taxes on major shareholders who own KOSPI stocks worth more than 1 billion won ($771,900) in a single company.
Those whose stakes exceed 1 percent of total shares on the KOSPI or 2 percent of total shares listed on the secondary Kosdaq market are also subject to capital gains taxes.
“The regulation leads to massive offloadings of shares every end of the year to avoid taxes, and lower the valuations of related stocks,” Jung said.