In recent months, South Korea has enacted a series of policies aimed at stimulating its stock market, hoping to replicate the robust growth seen in Japan’s marketHowever, despite these efforts, the performance of South Korean stocks has continued to falter, amidst a backdrop of political tumultThis has resulted in a challenging dual crisis where both the stock market and the currency face pressures, and the so-called "Korea discount," a term that denotes the undervaluation of South Korean companies compared to their true worth, is becoming even more pronounced.

Analysts are increasingly expressing concern that the political instability in South Korea is compromising the government's initiatives to boost market valuations and reform its conglomerates, known as chaebolsAdditionally, uncertainties surrounding U.Strade policies could have adverse effects on major industries in South Korea, notably semiconductors and automobiles, which heavily influence the market

As a result, the prospect of rectifying the Korea discount seems bleak, bordering on illusory.

The "Korea Discount" phenomenon stems fundamentally from the nation's unique economic structure, heavily influenced by its chaebolsDespite strong cash flow and profitability of many South Korean firms, a significant number of publicly listed companies are trading below their book value, a situation that has persisted for over a decadeDuring this time, while South Korea has achieved developed nation status with steadily growing GDP figures, the stock market has not performed as well in comparison to global counterparts.

The KOSPI, South Korea’s primary stock market index, is home to giant companies such as Samsung Electronics, LG Energy Solution, and SK HynixHowever, by mid-December of the current year, KOSPI’s average price-to-book (P/B) ratio stood at only 0.88, yielding an annualized return of merely 2.2% over the last ten years, with more than half of its companies trading below their book value

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In stark contrast, Japan's Nikkei 225 is at a P/B of 2.2, and the S&P 500 boasts a remarkable 5.25.

This persistent state of undervaluation creates a dilemma known as a "value trap," wherein publicly listed companies maintain low valuations despite solid earnings, leading to investor disillusionment and a self-perpetuating cycle of declining confidence among potential investors.

In response to these challenges, the Financial Services Commission of Korea announced on January 17 that it would implement a "Corporate Value Enhancement Plan" intended to address the valuation issues within the stock marketThe emphasis of the announcement was clear: companies that prioritize shareholder returns would be eligible for substantial incentives and tax breaks, alongside the establishment of indices and fund constructions centered on exemplary corporations.

The root causes of the Korea discount are intertwined with the chaebol-driven economy, and the government identifies several factors leading to these valuation challenges: a lack of transparency in corporate governance, insufficient shareholder returns, and a noticeable disparity in treatment between minority and majority shareholders

These issues are exacerbated by the significant market dominance of chaebol enterprises, mired by governance issues, intercompany transactions, and a general disregard for shareholder value, leaving small investors vulnerable.

Recent data indicates that as of 2021, conglomerates such as LG Electronics, Hyundai, SK Hynix, Lotte, and Samsung accounted for 60% of South Korea's GDPSamsung’s 15 affiliates alone represented 20% of the nation’s total GDP that year.

Looking at dividend payouts, South Korea's KOSPI index had a payout rate of merely 27.8% in 2023, substantially lower than Japan's Nikkei 225, whose payout rate increased from an average of 37.9% over the past five years to 50.57% in 2023, underscoring the disparity in shareholder return practices.

In light of these developments, FXTM chief market analyst Yang Ao-zheng argued that higher revenues and dividend payouts instill greater confidence among shareholders, leading to heightened interest in stock investment yields and dividends, consequently enhancing the overall trading atmosphere and market capitalization, creating fertile ground for the Japanese market's recent highs.

However, the absence of stringent governance and the lack of interest from controlling shareholders in enhancing shareholder returns have contributed to a continued decline in foreign investment in the South Korean market, which as of October 2024 stood at only 33%, below the average of the past decade.

As observers take stock of how South Korea's reforms echo those seen in Japan, we look towards 2023 as the Tokyo Stock Exchange implemented reforms concerning price-to-book ratios, mandating that firms listed on major and standard markets adopt measures aimed at managing capital costs and stock prices, significantly enhancing expectations for improvement in Japan's market valuations.

In the context of valuations, companies listed with P/B ratios below 1 are now required to provide explanations and take corrective actions

Recommended actions include stock buybacks to improve market valuations and return on equity, timing adjustments to corporate strategy, focusing more on capital returns, and improving transparency in public disclosures.

Following reforms, the Tokyo Stock Exchange announced on January 15 that it would publish a monthly list of firms responding to this initiative, hinting that those failing to effectively utilize capital might face delisting by as early as 2026. This accountability approach has catalyzed numerous companies to unveil value enhancement strategies.

In a similar vein, South Korea unveiled its own "Corporate Value Enhancement Plan" in February 2024, aimed at encouraging companies to assess their lower-than-average valuations and consider corrective measuresThese measures can include enhanced disclosures, increased dividends, stock buybacks, and overall improvements in operational performance.

However, unlike Japan's approach, South Korea's scheme leans heavily on voluntary participation, which has seen limited uptake, raising substantial uncertainties regarding its potential to invigorate the mid-term capital market

As of August 2024, due to a lack of enforced participation from the government in the value enhancement plan, only 18 companies chose to participate — reflecting a participation rate of less than 1%. Notably, among major players, only Hyundai Motor has disclosed a value enhancement strategy.

Analysts agree that the unique corporate culture, ownership structures, and investor dynamics in South Korea make the Korea discount an entrenched issue within the market's frameworkWithout mandatory measures to drive broader participation in valuation enhancement initiatives, the incentives for corporate owners and management to foster change remain minimal.

Turning to the manufacturing sector, South Korea's industrial output constitutes a significant portion of its economy, valued at 530.8 trillion won and accounting for 22% of the nation’s GDP in 2023, markedly exceeding those of other developed nations like the U.S

and JapanHowever, the manufacturing landscape is becoming increasingly pressured by competition from emerging economies and the retraction of American manufacturing capabilities.

Analysts point out that with a relatively small domestic market, South Korea's production of key industrial products such as semiconductors, machinery, automobiles, and chemicals is predominantly geared towards international marketsAs such, the economy is particularly sensitive to global economic fluctuationsOver the last decade, exports have consistently represented around 40% of the nation’s GDP.

In the latter half of this year, South Korea has witnessed a continuous deceleration in export growth over three months, with trade surpluses plummeting from $8.28 billion at the end of June to just $3.17 billion by OctoberAnalysts at Guotai Junan note that the high-end manufacturing sector, particularly electronic products, faces immense pressure due to reliance on U.S

technology and markets amid the global restructuring of the supply chain.

Fears are rising that if further tariffs on foreign goods are imposed, South Korea’s exports could suffer significantly, diminishing its products' competitiveness and impacting the profitability of export-oriented companiesGiven that semiconductors, automobiles, and chemicals are key sectors in the South Korean stock market, concerns over future export prospects are becoming a driving force behind market declines.

Guotai Junan's analysis suggests that breaking the stagnation requires focusing on technological innovation to cultivate new growth avenues, but the entrenched reliance on conglomerates limits South Korea’s capacity for disruptive innovationAdditionally, there is a pressing need to amplify the service sector, which has recently shown rapid growth in exports, surpassing traditional sectors like batteries and appliances, marking it as an increasingly crucial source of growth for the South Korean economy.