The title may seem like clickbait, especially given the recent market events in South Korea. To a degree, it is. But this article is about a deeper, important issue that we promised to be a part of this following article at the end of the last before events made writing about Korea  more attention-grabbing.

This topic, the costs and benefits of having one of the world's most undervalued equity markets, may not appear relevant either to events in Korea or for a series that focuses on GenAI and innovation. In fact, it is a topic the domestic media and analyst community never seems to have time for, least of it now. However, the issue is linked to the tendency of those in power to work hard in the name of national interests and feed on the "foreign interest" paranoia to perpetuate their influence. Our job is not to think about what may or may not happen but to discuss the likely path of Korean innovations and the implications of investments in a global portfolio by the end.

A Nationalistic Society that Dislikes Local Investing

Most societies have a substantial home market bias, but Korea stands at the opposite extreme—exhibiting a glaring aversion to domestic investments. The contradictions, ones to which everyone investing in Korea has grown accustomed, and the indifference to them is odd, considering the high economic and societal costs.

South Korea is one of the world's most patriotic and nationalistic societies, a sentiment dramatically displayed during the 1997 Asian Financial Crisis. In an extraordinary demonstration of collective sacrifice, citizens formed long queues to donate their gold and other valuables to help the government repay its external debt. It was a striking example of national solidarity, underscoring the depth of Korean patriotism.

Korea's economic transformation over the past 25 years is nothing short of remarkable.  From a per capita GDP barely a sixth of Japan's in the 1980s and a quarter at the depths of the 1998 Asian Financial Crisis, it surpassed Japan in 2024. This ascent is mirrored in the steady earnings growth of its listed companies. Along the way, Korea's cultural and technological prowess captivated the world, with its entertainment industry, tech brands, shipbuilders, automakers, gamers, digital transformers, and biotech firms achieving global recognition. There have been few asset or infrastructure excesses nor accusations of extreme government interventions or influences.

Korean investors have displayed a remarkable risk appetite, similar to those in Taiwan or India. Except that they do not have any time for their own country's stocks. They are one of the largest foreign investors in the US equities. Their passion for the crypto is folklore, often rivaling those from nations with no confidence in domestic systems and institutions. The erstwhile hermit kingdom, which still views any foreign investment in its own assets with near xenophobic suspicion, has domestic investors incessantly moving away in droves—comparable to the massive outflows seen from Japan who, did not have equivalent growth, China had no similar profitable industries, or MiddleEast without sufficient domestic investment opportunities.

Income Rich, Wealth Poor (Relatively)

As a result, Korean equities trade at some of the lowest valuations in any major global market. Everyone has developed a narrative to justify large corporates trading at deep discounts to book value - valuations not seen anywhere in the OECD or the emerging universe. An economy that does not feature near the bottom in any matrix has a market valued as the worse than all others. And still, unlike Intel's this week, these listed companies' managers, for instance, never come under pressure. "Value Up" is a fancy word where some may announce higher payouts or convert the usual annual promotion exercise into an event branded as the "Value Up" strategy. The markets react with a yawn, the media would get space for some articles, and life would move on.

One result of this paradox is a domestic wealth-to-GDP ratio that ranks among the lowest in the OECD. Although Koreans have proven highly adept at generating income, buoyed by the country's impressive growth over the past two decades, this has yet to translate into comparable levels of wealth accumulation. Despite surpassing Japan's per capita income, Korea's wealth metrics remain disappointing. This disconnection between income and wealth is a defining feature of Korean society and economic life. Positively, it has benefited its equality matrix. At the same time, it has negatively impacted consumption despite great economic success and a social and innovation culture with material long-term risks in the GenAI era.

Corporate Structures that Work for Managers

In this writer's personal experience, Korea has one of the hardest-working employee classes, which is often confirmed in global surveys of various countries' work hour tables. This is accompanied by a deference to managers and seniors that is more typical in military outfits. For the lower-tiered employees, the most common disagreements are in collective actions, manifested in the statistics of strikes and labor disputes.

From the investor viewpoint, the unique system has no one responsible for shareholder rights, interests, or value. In 2024, regulations still require directors to perform duties "in good faith for the interest of the company" without explicitly mentioning shareholders. Working for the best "interest of the company" has been a fancy word to work for the management.

For a few years, a proposal to amend Article 382.3 of the Korean Commercial Act has been proposed to make corporate boards more accountable to shareholder interests. Efforts to enact reforms in this area have faced staunch resistance from the powerful chaebols (family-owned conglomerates), who claim such reforms threaten national security and sovereignty. Their arguments are not too dissimilar in sound from those made by the President in imposing martial law.

Adding to this complexity is the contradictory behavior of Korean analysts, which also reflects the contradictions in the marketplace. They are, in theory, among the most optimistic; in this writer's previous role, studies always showed Korean analysts having the lowest percentages of Sell ratings globally. Yet, privately, their assessments would be most scathing, aligned with their portfolios, which had relatively few domestic investments. They would rarely have any arguments around the deep value, focusing primarily on earnings momentum and news flow. 

The Innovation Conundrum: R&D Without Wealth Creation

South Korea is a world leader in research and development, consistently boasting one of the highest R&D-to-GDP ratios globally. Across fields such as robotics, biotech, electronics, and media, Korean industries produce world-class innovations. Yet, the economic gains from these breakthroughs seldom extend to shareholders or society at large. Much of the innovation remains concentrated within large conglomerates, where a rigid, seniority-driven culture stifles individual creativity and entrepreneurial ambition.

In modern economies, equity serves as a powerful alternative currency. High market valuations enable companies to attract and retain talent through stock options, fund research through share-based acquisitions, and raise capital at favorable terms through secondary offerings. This equity-as-currency model has proven especially vital in the AI era, where companies must compete globally for specialized talent and intellectual property. Yet Korea's persistently low valuations create a striking handicap. Korean companies struggle to leverage their equity for growth. When shares of even profitable companies trade at 3-5 times earnings or below book value, stock-based compensation loses its allure.

Korean managers, without pressure from the board to lift valuations and driven by their promotion cycles, exhibit galling apathy, manifesting itself in their supposed "Value Up" presentations devoid of material or new ideas. A poignant example of management control comes from the entertainment industry, a sector synonymous with individual creativity. Recent conflicts involving prominent entertainment labels have highlighted how systemic issues within management can stifle even globally popular K-pop bands, suppressing the contributions of individual artists in favor of hierarchical control.

Without a thriving ecosystem that rewards innovation and risk-taking, the broader economy is at the least suffering from extreme underachievement of its outstanding efforts.

The Positives of Low Valuations: Efficiency and Cost Competitiveness

When the cost of risk capital is enormous, it does not have to stop innovation as Korean corporates prove repeatedly. Their volume focus provides the world with competitively-priced products and services that are comparatively less expensive than what they could have been. More importantly, as discussed in the previous article on China, focusing on efficiency without readily available capital leads to innovations that do not target better capabilities at any cost. Many GenAI models, for instance, developed in the West, presume that the best way forward is through ever more resources - something that may not always be true. 

Can there ever be genuine Korean corporate reforms or rerating?

GPUs are no longer considered commodities, but memory, where Koreans reign supreme, has followers who expect a downturn at every corner because they lack faith in their manufacturers' logic to focus on profits or understand their monopolistic powers. The issue is similar in volume-driven management focus in other industries, like autos, shipbuilding, or robotics.

Every discussion of proposed amendments, like the article discussed above, with supposed support from all political parties, raises some hope. Still, market veterans roll their eyes and cite numerous examples from the recent past, behind closed doors, of how management practices and focus are much the same.

In evidence-based investing like what we follow, we do not have any hopes of sustainable re-rating where Korean discount - often 80% or more in PB terms for some of its best companies - becomes more rational in the foreseeable future. It should not be this way, and for any change, Korea's investors must take the lead.