What is the holding company discount: why a holding company trades below its subsidiaries combined

A holding company owns shares in other companies instead of factories or stores. Its core business is holding stakes in subsidiaries and controlling them, so on a separate basis the holding company's own sales are mostly dividends from subsidiaries, brand royalties and rent. Holding companies divide into pure holding companies, which run no business directly, and operating holding companies, which run a business themselves while also controlling other subsidiaries.

In Korea, many large business groups are organized under a holding company structure, and several financial holding companies that put banking, cards, securities and insurance under one roof are listed as well. So Korean stock lists often include companies with “Holdings” or its Korean equivalent at the end of their names, and these companies' metrics need a different reading from those of operating companies.

Add up the listed subsidiary stakes a holding company owns at market prices, estimate unlisted subsidiaries without a market price at book value or by reference to similar companies, and the result is the value of the holding company's assets. For a holding company that runs a business directly, the value of that business is added too. Subtracting the holding company's own net debt, that is, debt minus the cash it holds, gives net asset value, and set against the holding company's market cap, the market cap is usually smaller. That gap is called the holding company discount, and the gap as a percentage of net asset value is called the discount rate.

This pattern has been observed for a long time in Korea and elsewhere, and its size varies by country and period. The existence of a discount does not mean the holding company is bad, nor that its shares are priced low. It only shows that the market values assets held inside the container of a holding company, taken as a whole, at less than the same assets taken one by one, and why it values them less is explained by the reasons in the next section.

The first is the same earnings being counted twice. When a subsidiary is listed separately, its earnings are already reflected in the subsidiary's market cap. Fully counting those earnings again in the holding company's market cap would mean the market as a whole prices the same earnings twice. Investors can invest in the subsidiary directly, so there is no reason to pay full value again for the same earnings through the holding company, and the price is cut by that much. The second is the path of the money. Earnings a subsidiary makes stay at the subsidiary, and only the amount set as dividends flows up to the holding company. What holding company shareholders can actually receive is the money paid out again as dividends after the holding company's costs and interest are taken from those dividends, so the subsidiaries' entire earnings are hard to count as belonging to the holding company's shareholders.

The third is governance. The controlling shareholder controls the whole group through a single stake in the holding company, so the concern that the holding company's decisions may favor the controlling shareholder over minority shareholders is reflected in the price. The fourth is attention and trading. When subsidiaries are each listed, investors can invest in only the businesses they want, so they have little reason to seek out the bundle that is the holding company, and thinly traded stocks carry a lower price accordingly. The four overlap, and how much each one matters differs by company.

A holding company has two sets of financial statements, consolidated and separate, and Jupick uses consolidated first. Consolidated financial statements combine all the sales, earnings and debt of the subsidiaries it controls, so the revenue growth, operating margin and debt ratio shown on screen for a holding company are in effect the sum of its subsidiaries. Earnings of associates, companies over which it has significant influence but no control (generally a stake of 20 to 50 percent), are not combined; they are added below operating income as equity-method income. When equity-method income is large, there are years in which net margin exceeds operating margin even after interest expense and corporate tax. For companies with a smaller stake than that, only the dividends received are recorded as income, not equity-method income.

In the separate financial statements, the same company shows completely different sales and margins; why, and which basis Jupick uses, is set out in detail in the related-reading article on companies that publish two sets of financial statements. This article only points out that a holding company's metrics are not the results of one company but values that combine several companies.

PBR is the share price divided by book net assets per share. Subsidiary stakes recorded in the separate books are usually carried at their acquisition cost or at a value built up through the equity method, and even on a consolidated basis, subsidiaries' assets carry over their book values from the time of acquisition and differ from current market prices. So a holding company PBR below 1 is common, and rather than reading it by itself as trading below book value, the first thing to look at is how far book value is from market value. The industry recalculates net asset value using the market value of subsidiary stakes instead of book value to measure the discount rate, and Jupick does not calculate this value.

When PER (price to earnings ratio) uses consolidated net income, all subsidiary earnings come in, and that net income is split at the bottom of the income statement into the portion attributable to owners of the parent and the portion attributable to non-controlling interests. A holding company's PER makes sense on the basis of net income attributable to controlling shareholders, and years with large equity-method income are hard to compare with years without. The PER and PBR Jupick shows on screen use consolidated net income and consolidated total equity as is, so they include the earnings that go to non-controlling interests. They are not values calculated only on the earnings that go to controlling shareholders, so for a holding company that owns only a little over half of its subsidiaries, they come out lower than values recalculated on a controlling-shareholder basis. Which yardstick fits which kind of company is covered in the article on choosing a valuation metric, and a holding company comes close to being a company that none of those yardsticks fully fits.

Jupick does not flag holding companies separately or calculate net asset value and the discount rate. Holding companies are graded on the same nine metrics as other stocks. Sectors follow the data source's classification, and many Korean pure holding companies are classified under other financial services even when they are not financial holding companies, so on Jupick they also sit in the financials sector alongside banks and insurers. A holding company that controls manufacturing affiliates may not turn up when looked for under information technology or industrials. For banks and financial holding companies, interest expense is part of operating costs, so interest coverage cannot be formed as a fraction at all, and Jupick treats that metric as not applicable. Operating margin is mostly left out as undisclosed, because in the summary financials from the data source, DART (Korea's electronic disclosure system), many of these companies have no operating income line, though a value does appear for some. Cases where a whole metric drops out because of the sector are covered separately in the related-reading article on why banks have no current ratio.

So a holding company's grade and metrics should be read not as the condition of one company but as the sum of the many companies it controls, and it is also worth noting that when holding companies are mixed into a sector comparison, the group median shifts. This article does not cover when the discount may narrow or widen, and metrics are only a basis for reading a company's current condition; they do not suggest trading any stock and say nothing about future prices. This content is for information only and is not investment advice. Investment decisions and responsibility for them rest with the user.