Why South Korean Stocks Trade at a Discount — And Why That Could Change

During their recent episode, Taylor, Carlisle, and Ryan Albert discussed Why South Korean Stocks Trade at a Discount — And Why That Could Change. Here’s an excerpt from the episode:

[Ryan] Yeah. Well, first talk about the Korea discounts. I think it’s important to really zoom in on the Korea discount because it’s easy to say there’s a discount and it exists.
But I think that the discount, simply put, is just the price of being a minority partner to family-controlled companies and they dictate how the rules are set. So if you’re a family-controlled business, this is generalising for all families, but controlling shareholder groups think in many different ways. But you want control, right?

And control means that cash stays inside the company and that’s used for cross-shareholdings instead of being divided out, buying treasury shares and not retiring them, buying real estate, doing things so the cash does not leave the business. And then that also means succession to keep control. And succession means the next generation needs to acquire the controlling stake cheaply.

So a low share price is wanted because inheritance tax is paid off of the share price. So it’s a formula that’s generally set around two months before and two months after the gifting. And that’s up to 60%.

It’s one of the highest in the world. It’s 50% plus a 20% control premium. So basically up to 60% when you gift.

So now you can see why companies want to depress their share price. There’s really no incentive to get it up. So why now?

The issue became political and there’s many different stats of how many brokerage accounts there are and how many retail stock investors. But I think the last time I checked, there’s around 15 million retail stock investors in Korea now. I think that’s up from like 5 million pre-pandemic.

Don’t quote me on that, but I think those are the numbers that I’ve heard or seen recently. So this retail base is a huge investing block. It’s a huge political block now.

[Tobias] And that’s sort of like a population of 50 million.

[Ryan] Yeah. And then even adults, it’s a huge block.

[Jake] Isn’t it like two accounts for every one adult or something?

[Ryan] Yeah. Maybe even more. So it’s some crazy number.

So that became a huge powerful block. So that’s one issue. And then the second is just, I think the Japanese example showed what is possible.

So from 2013, the Tokyo Stock Exchange and Abe government enacted a whole set of governance reforms. And the topics I think had doubled while the Korean index had been flat for that period of time. So basically showed what’s possible if change is enacted.

So yeah, so the first iteration under this started under the previous Yun government and that was with the corporate value up programme, but it was totally optional and there was not that much compliance. And then the new president came in and he’s on the democratic party and they already had kind of a controlling or they had a majority in the national assembly. So it was easier to start passing rules through.

And basically it’s the purpose of getting all this done is to create like an actual vehicle for retail investors and the population to know that they’re not going to be junior partners to controlling shareholders when they invest. Because historically, I think it’s something like two thirds or three quarters of savings for most families go into real estate. And that’s exact opposite of the U.S. I think the U.S. is like a quarter or one third or something like that. So most families have their wealth tied in the real estate and real estate is at sky high prices like Seoul is some of the most like unaffordable real estate prices. So the whole goal is have families invest wealth into the stock market and have them have confidence investing into the stock market. So these reforms have started to be enacted, which have basically been trying to solve for these governance or these Korea discount issues.

So I’ll pause there. And why now is a whole set of reforms have been rolled out over the past year and a half since the new president has come in. Some of them have are in the process of being promulgated.

Some of them have already been enacted. Some of them are just talk speculation. But in general, a lot has changed in a year and a half time frame versus what happened in Japan over a 10 year span.

So compressed. Time frame for these changes happening in a market that got ahead of itself a little bit, I think, because of just the importance of Samsung and SK Hynix. So I’ll pause there, but that’s a little bit of the history of the discount and why now and all these reforms.