[Edaily Marketin LEE GEON-EOM Reporter] As the government moves forward with a plan to label undervalued listed companies as having a “low price-to-book ratio (PBR),” critics are pointing out that blanket categorization without qualitative analysis could actually exacerbate market confusion. It is explained that even among companies with low PBRs, their capacity for shareholder returns varies significantly depending on the reasons behind the increase in their net assets. In the market, there is growing support for the view that companies whose net assets have increased through accumulated profits from operating activities should be distinguished from those whose book value has merely risen due to asset revaluation.

According to the financial investment industry on the 24th, the Korea Exchange (KRX) will announce its first list of low-PBR companies on November 2. The list will target KOSPI companies with a cumulative three-year PBR in the bottom 25% of their respective sectors and KOSDAQ companies in the bottom 10%. The PBR reference date for this first announcement is the 22nd of next month.

PBR is calculated by dividing the stock price by net asset value per share. It is an indicator showing how many times a company’s market capitalization exceeds its book value. If the PBR is less than 1, it means the company’s market valuation falls short of its net assets. For this reason, companies with a low PBR are generally classified as being undervalued.

The issue is that the significance of the indicator varies depending on how the net assets—the denominator of the PBR—have increased. If net assets increase while the stock price remains unchanged, the PBR decreases. This structure means that companies whose net assets have grown by accumulating earnings from operations and those whose net assets have grown by increasing the book value of their assets can both be grouped under the same “low PBR” category. This is why there are concerns that categorizing companies solely based on PBR figures may fail to accurately reflect their actual value.

Experts cite retained earnings and asset revaluation as the key distinguishing criteria. Retained earnings are the portion of a company’s net income from operating activities that is retained within the company rather than distributed externally through dividends or other means. Companies with substantial retained earnings are considered to have sufficient capacity to engage in substantive shareholder returns, such as dividends or share buybacks.

Asset revaluation is an accounting method in which a company reevaluates its tangible assets—such as land and buildings—at fair value to adjust their book value. When real estate prices rise, the revaluation gain is reflected in equity. However, unless the assets are actually sold, no cash flows into the company. In effect, only the net assets on the balance sheet increase, while the PBR decreases.

The Commercial Act also distinguishes between these two scenarios. It stipulates that unrealized gains resulting from asset revaluation must be deducted when calculating distributable earnings. This means that the increase in net assets from asset revaluation cannot be used as a source of dividends until the assets are sold and the gains are realized.

This is why experts view companies whose PBR has fallen due to asset revaluation as “value traps.” A value trap refers to a situation where investors buy into a stock because it appears cheap, but the stock price remains at a low level because the company’s underlying value has not improved.

Differences also emerge in terms of capital efficiency. Return on equity (ROE), calculated by dividing net income by shareholders’ equity, shows how efficiently a company has utilized shareholders’ capital to generate profits. If only equity increases due to asset revaluation, ROE will decline even if profits remain unchanged.

For assets subject to depreciation, such as buildings, depreciation expenses may increase after revaluation, potentially leading to a decrease in net income. Since an increase in net assets does not necessarily translate into improved profitability, critics point out that it is difficult to interpret a decline in PBR in such cases as a sign of undervaluation.

There are concerns in the market that if the “undervalued” label is applied indiscriminately even to companies that have merely inflated their size through asset revaluation—those that are “low PBR in name only”—it could lead to investor misperceptions and misjudgments. This is because the mere fact that the government has classified a company as undervalued could be accepted as the basis for investment decisions.

An official in the financial investment industry pointed out, “Even among companies with low PBRs, they should be viewed as entirely different entities depending on how their net assets increased,” adding, “Lumping together companies that have accumulated retained earnings through operations with those that have merely inflated their book value through asset revaluation is a classification that lacks qualitative analysis.”

He continued, “Net assets increased through asset revaluation do not represent actual cash inflows, so they are unlikely to translate into dividends or share buybacks,” adding, “If even such companies make it onto the undervalued list, investors could make erroneous judgments based solely on the PBR figure.”

Another financial investment industry official also emphasized, “Rather than blindly trusting the surface-level PBR figures, investors should soberly assess a company’s fundamentals by examining its actual cash generation capacity and capital efficiency.”