Kosdaq is so hot that analysts fear a bubble

The rally in Korea’s smaller companies that drove stock valuations to all-time highs is prompting the nation’s biggest money manager to warn of a bubble.

The small-cap Kosdaq Index is valued at 18.3 times projected earnings, the highest since Bloomberg began tracking the data in November 2011. The gauge has jumped 13 percent this year through Monday, outperforming both the benchmark Kospi and the MSCI Emerging Markets Small Cap Index by about 11 percentage points.

“The Kosdaq’s valuation is too stretched now,” Park Heewoon, head of research at Samsung Asset Management, Korea’s biggest private money manager with about $164 billion under management, said. “There could be a bubble.”

Smaller companies have benefited from government measures to promote entrepreneurship and improving domestic demand as a relatively strong won and weaker global outlook spoils exporter earnings. Samsung Asset Management and Midas International Asset Management say valuations overestimate potential earnings growth. Eighty-three percent of Kosdaq companies that reported fourth-quarter results as of yesterday trailed analyst estimates, compared with 66 percent that missed on the Kospi.

Celltrion, an Incheon-based pharmaceutical company, has rallied 89 percent this year through Monday, the most among stocks on the MSCI Emerging Markets Index, giving it a market value of $7.1 billion. Silla Textile, a maker of synthetic fibers, has jumped 1,013 percent in 2015, while Nuvotec, a manufacturer of plastic pipes, has surged 280 percent even after saying Feb. 2 it swung to a 2014 net loss.

The Kosdaq, whose companies have a median market value of $60.9 million, is outperforming the Kospi by the most since March 2010.

The index of large-cap stocks, which has a median value of $181 million, fell last month to its lowest level since August 2013.

“Because Kospi earnings keep disappointing investors and there’s not much expectation of improvement either, people turned to Kosdaq companies,” Heo Pil-seok, chief executive officer at Midas International Asset Management, which oversees $9.4 billion of assets, said. “Although there’s growth potential, many stocks have become too expensive. If investors start to unwind their position, such companies could be very vulnerable.”

Hyundai Motor, the nation’s second-largest company by market value, has fallen 3.9 percent this year, extending 2014’s 29 percent plunge. The company reported a 19 percent drop in fourth-quarter earnings from a year earlier.

While it’s important to pick between “gems and pebbles,” Kosdaq companies have better long-term potential given their focus on “high-growth” areas including the Internet, health- care and biotechnology, says Kim Jung-ho, strategist at HMC Investment Securities.

Technology companies account for 39 percent of Kosdaq’s overall weighting, while drug-makers comprise 18 percent and consumer discretionary stocks another 17 percent. Samsung Electronics and Hyundai Motor, part of two of the biggest Korean conglomerates, known as chaebol, account for 20 percent alone of the large-cap gauge.

“I don’t think the rally is fueled by misplaced optimism,” Kim said. “People are looking for a new growth engine.”

The government is also looking to boost business outside of the chaebol, which dominate traditional industries from automaking to consumer electronics and shipbuilding. President Park Geun-hye established a body last year to provide assistance to small- and medium-sized companies and pledged to help entrepreneurs get financial aid without collateral.

While smaller companies are more attractive in terms of future growth, they’re becoming too expensive to buy right now, says Nam Dong-woo, head of equities at Eastspring Asset Management, which oversees about $11 billion.

The Kosdaq trades at a 65 percent premium to the Kospi’s 11.1 times projected earnings, while its 14-day relative strength index was 73.2 yesterday, above the 70 threshold that signals to some traders gains are overdone. Celltrion is valued at a multiple of 79 times on a reported basis, while its RSI climbed to 89.7.

“I do plan to increase exposure to Kosdaq market when I find shares that have sustainable growth story,” Nam said. “But for now, prices are too high. I may try to find opportunities in big Kospi players given how cheap they are.”

Bloomberg