Korea: High innovative power at discount prices

» The Korean equity market slumped by ten percent in 2018.

» Korea stands for high innovative power: in relative terms, no state invests as much in research and development

» The low valuation of the equity market does not reflect the high quality of the country’s companies or the above-average earnings growth.

The conflict between North Korea and the US has until recently also depressed equity prices in the “Republic of Korea”, which is the official name of South Korea. A price recovery has not set in yet, with sentiment dampened especially by the trade conflict between the US and China.

Korean companies and the government invested USD 73bn in research and development projects in 2016, with only the US, China, Germany and Japan having spent more.

High expenditure on research and development is a double-edged sword: companies promote their activities, while investors are concerned that high expenditure will put pressure on profit margins. In actual fact, we believe that R&D expenditure in a healthy growing industry contributes significantly to the long-term appreciation of a company’s value, in terms of intangible assets and future sources of income. Korean companies attach above-average importance to product design and quality, and are less interested in competing over the product price. This strategy makes them less susceptible to currency fluctuations in the export business, than is likely to be the case for technology companies in China.

The valuation of the Korean market is among the lowest worldwide. The price/cash flow ratio is currently 4.5, the PER 8.6 and the price to book value ratio 0.9. These values make the Korean equity market, together with the Russian and Turkish markets, one of the cheapest in the world, with a significantly better risk/return profile. The valuation discount is attributable to the corporate governance reservations of international investors, concerns about a revival of the North Korean conflict and the conflict between China and the US.

Korea’s long-term growth outlook appears excellent. Earnings growth is above average, as is the quality of the listed companies. This provides protection against the macroeconomic burdens within Asia, especially arising from the trade conflict between the US and China. The equity market is expected to generate excess returns over other emerging markets in the coming quarters.

 

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