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Should You Invest in South Korea Right Now? Consider These Four Issues First

An “inhumane crime.”

In a seven-minute address to the nation today, that’s how South Korean President Lee Myung-bak described the latest round of aggression from its North Korean neighbors.

Tempers have flared, following North Korea’s military attack on a South Korean island last week, which killed two South Korean marines and two civilians. The deaths have sparked one of the most serious clashes between the two adversaries in many years.

The reminder of such a fractious relationship has rattled the markets, with indexes across the globe selling off after the attack.

So with tensions high, what does this mean for investors?

South Korea: An Investment Paradox

In truth, investing in South Korea has presented financiers with a paradox for some time. For example…

  • Why is a country with a GDP of $1 trillion and a per capita income of $28,000 still classified as an emerging market?
  • Why does South Korea have a stock market that routinely trades at a 10% to 40% discount to its regional peers, given that it boasts the globe’s most wired infrastructure and is home to the largest technology firm in the world?

Here are four reasons for the South Korean discount – and factors that you need to know before you invest…

Four Factors to Consider Before You Invest in South Korea

We start with the biggest and most obvious issue for South Korea…

  • Geopolitical Risk

Erratic. Opaque. Heavily armed. Just three ways to describe South Korea’s nemesis to the north.

The tension created and risk involved here certainly has an impact on how potential investors view South Korean opportunities. Flare-ups seem to occur on a regular basis. It was only in March that a South Korean navy vessel was sunk, resulting in the deaths of 46 sailors. Certainly much more than just a run-of-the-mill border incident.

North Korea aimed last week’s attack at Yeonpyeong Island, which sits just two miles from the Northern Limit Line, the disputed sea border that the North doesn’t recognize and only eight miles from the North Korean coast. It’s also home to 1,000 South Korean marines.

South Korea has support from the United States here, as well as many others around the world, but there are other factors to consider before investing in this emerging market, such as…

  • Cyclical Businesses

If you peel the onion, you find that many of South Korea’s corporate leaders are in cyclical industries such as technology (Samsung), the auto industry (Hyundai), chemical, steelmaking and ship building. That works well during positive times, but leaves the country susceptible during downturns.

  • Top-Heavy Corporate Structure

Following the Japan model, the South Korean economy is founded on massive conglomerates (chaebol) that dominate its economy and market. For example, Samsung accounts for 14% of South Korea’s stock market value. That’s more reasonable today, but it was as high as 30% not so long ago.

This high concentration of power isn’t a great environment to spawn new high-growth start-ups. It also leads to the lowest dividend yields in the region – a paltry 1%.

In basketball terms, South Korea’s starting companies are world-class, but it has a weak bench.

  • Dependence on Foreign Investors

South Korean investors tend to work on momentum, piling in at the top and fleeing at the bottom. However, overseas investors drive the market through these cycles and normally play South Korea as a “middle way” between Japan and China.

So what’s the bottom line on investing in South Korea?

The Benefits of Investing in South Korea

Aside from the issues mentioned above, there are several potential benefits of investing in South Korea…

  • For example you’ve got dependable 4% to 5% annual economic growth.
  • A strong trading relationship with China and a leveraged play on global industrial growth.
  • Another bright spot is the recent pension reforms that will lead to domestic funds and South Korean institutional investors playing a larger role in their market going forward.

And as for the South Korean stock market discount that I mentioned at the start, the Kospi Index is currently trading at about 10 times 2010 earnings, versus 15 times for the MSCI All Asia index.

So when considering an investment in South Korea, the healthy discount certainly counts in its favor. But be sure to fully weigh up the pros and cons before you pull the trigger.

Good investing,

Carl Delfeld

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Wall Street analysts.


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