The ‘Korea Discount’: Value Stock or Value Trap?

• South Korea’s markets have been plagued by what is commonly called the “Korea discount,” where stocks are valued lower or assigned a higher risk premium than their global peers.
• While this may seem like a market opportunity to investors to sink money into South Korea so as to take advantage of the undervaluation, analysts think it is not that simple.

South Korea’s stock market, despite being home to Asia’s fourth largest economy, is often considered undervalued by analysts, leading to what is sometimes referred to as the “Korea discount.”

Data from the Korea Exchange showed that the Kospi benchmark index as a whole has a price-to-book ratio of 0.92, and its price-to-earnings ratio stood at 18.93. A price-to-book ratio measures whether a company’s share price is undervalued, with a number below 1 indicating the stock may be below fair value.

The “Korea discount” refers to a tendency for South Korean securities to be assigned lower valuations or bear an inflated risk premium by investors, explained Vikas Pershad, portfolio manager for Asian equities.

For investors who subscribe to the idea that prices will gravitate toward fair value, an undervalued market could be a great investing opportunity.

But it may be more complex than that.

If stocks continue to be undervalued, what appears to be a value buy for investors could quickly turn into a so-called value trap — where investors buy what appears to be a relatively cheap stock, only for the stock price to continue falling or remain stagnant.

So, why is there the “Korea discount”?

There are a number of reasons for this, according to Jiang Zhang, head of equities at investment firm First Plus Asset Management. They include geopolitical risks involving North Korea, corporate governance, limited foreign investor participation and most notably, the company’s management or corporate structure, he told CNBC.

Chaebol challenge

In South Korea, most market heavyweights are corporations called “chaebols,” large family-owned global conglomerates that are usually controlled by the founder’s family. These may consist of a group of companies or several groups of companies.

Notable chaebols include market heavyweights such as Samsung Electronics, LG, SK and Hyundai.

Chaebols make up a huge part of the South Korean economy. One such example is Samsung and its affiliated companies, which contributed 22.4% to South Korea’s GDP in 2022.

However, these very same companies are part of the reason behind the Korea discount phenomena.

Chaebols “often have complex corporate structures which have resulted in poorer governance, transparency, and shareholder rights,” said Jeremy Tan, CEO of Tiger Fund Management, the fund management arm of online brokerage Tiger Brokers.

Zhang pointed out that under the family-owned structure of chaebols, investors hold little sway over the company’s strategic direction.

He highlighted that family owners, by virtue of having a dominant stake in the company, may pursue businesses that are unrelated to the core business or are loss-making, which will destroy shareholder value.

Dividend dilemma

Some investors may take the position that a lack of capital gains is acceptable for their portfolio because they plan to hold stocks for dividend payouts.

However, IHS Markit highlighted in June last year that in South Korea, the ex-dividend date comes before the companies’ dividend announcement dates.

As such, shareholders of South Korea stocks face a unique set of risks and opportunities as they are expected to hold their share through the ex-dividend date without knowing how much dividend will be distributed.

The ex-dividend date refers to the date that an investor needs to own a stock in order to receive the dividend. This is unlike companies in most other advanced markets, which announce their dividend payout and ex-dividend date before the ex-dividend date passes.