Hidden in Plain View: The South Korean Bull Market

south-korean-bull-marketIt was a stock market almost forgotten by global investors for three years. Even this year, it’s been overshadowed by stronger performances in the Chinese and Japanese markets.
The market in question is the South Korean stock market.
It is up roughly 10% so far this year and is trading at levels not seen since 2011. Despite being overlooked, the Korea Composite Stock Price Index, or Kospi, is now less than 200 points away from its all-time high of 2228.96, set in May 2011.
As with other global stock markets, the South Korean bull market has floated higher on the sea of liquidity provided by the world’s central bankers. Its own central bank cut the key interest rate to a record low of 1.75% in March.
But there is a lot more at work here than just liquidity. After all, foreigners have purchased about $7 billion worth of Korean stocks so far in 2015. That is more than in all of 2013 or 2014.

South Korean Companies Are Growing and Cheap

One reason for money managers’ moves back into South Korea is simply valuation.
The Kospi price-earnings ratio stands at 11.1 times projected earnings for the next 12 months. That is well below most of its Asian peers and the 16.4 reading for the MSCI global index. I might add, it is also well below the forward P/E ratio of the S&P 500.
The lower valuations are especially attractive when one takes into consideration the growth some companies there are experiencing. This is particularly true for companies exposed to the booming Chinese consumer sector.
One example of a company enjoying growth thanks to China is South Korea’s largest cosmetics maker, AmorePacific (OTC: AMRWF). Over the past five years, its share of the cosmetics market in China has quadrupled to 4%. It’s not surprising then that it is up 75% already in 2015.

Reform, Dividends Are on the Rise

South Korea is also taking a page out of the Japanese corporate reform playbook.
The Korean government is pushing hard to reform the chaebol. These are the large family-owned conglomerates that have strong ties with government agencies. To say that chaebols have historically been very unfriendly to minority shareholders is a vast understatement. Poor corporate governance and lousy dividends have been the key culprits in the Korean market’s poor performance and cheap valuation.
That is finally beginning to change, however. Many of the larger companies, such as Samsung Electronics (OTC: SSNLF) and Hyundai Motor Co. (OTC: HYMLF), have promised to return more of their huge corporate cash piles to shareholders. These two companies alone account for about 20% of the Kospi’s weighting.
Samsung and Hyundai raised their 2014 dividend by 41% and 50%, respectively. Samsung also bought back $2 billion of its shares – its first buyback in seven years. It is also believed to be contemplating a stock split to allow more people access to its stock.
Other major Korean companies are joining in. For example, in January LG Display Co. (NYSE: LPL) announced its first dividend in four years.
Of course, much of this largess is due to the new government tax policy. The South Korean government is offering incentives for increases in dividends. And it is now slapping a special tax on retained earnings if not used within three years. That’s a real incentive to a company like Samsung, which was sitting on a $50 billion cash pile.

A Look Ahead and How to Profit

This is likely to be just the start of reform of the chaebol. The dividend payout ratio in South Korea is still well below its Asian peers in Japan and Hong Kong – not to mention its global peers. Even with its raised dividend, Samsung’s payout of 12.5% of last year’s profit is far less than Apple’s (NASDAQ: AAPL) 28%.
More prodding from the government and shareholder activists will keep the ball rolling. Add in low interest rates and low oil prices and you have the makings of a very good stock market environment in South Korea.
Most of the better Korean companies are not traded at all in the U.S., or are only very thinly traded in the over-the-counter market. That means the best bet for U.S. investors is exchange-traded funds.
My favorite way to play the Kospi index is the iShares MSCI South Korea Capped ETF (NYSEArca: EWY). It is up nearly 11% year-to-date.
Another interesting ETF to invest in Korea is the First Trust South Korea AlphaDEX Fund (NYSEArca: FKO). It is much more thinly traded, but among its larger positions are companies like AmorePacific and other consumer-related stocks. It’s up 13.25% year-to-date.

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