Sunken Shippers Look Ready to Float Again

My last five columns have dealt mostly with behavior and psychology. All the successful investors and traders I've ever known have had one common element -- the behavioral element.

In other words, they've all had the discipline, patience, detachment, and alignment that I spoke about previously. It didn't matter whether they were value investors, chart followers, momentum investors, long-term, short-term; the common denominator was the behavior.

Are you ready?
Now, I'm going to get off the theory a bit and apply some of what we learned to a real life example. Let's pick some stocks!

Peter Lynch, the great manager of the Magellan Fund, and Warren Buffett, who needs no introduction, both spoke about buying what you know. I'll use an example of that here, along with some other ingredients that I've found useful in successfully picking stocks -- namely, value and contrarian timing.

In this example, I'll look at the ocean-going shipping industry. A little over a year ago, the names in this group were some of the hottest and highest flying in the market. I'm talking about companies like Knightsbridge Tankers (VLCCF), OMI (Nasdaq: OMM  ) , Frontline (NYSE: FRO  ) , and General Maritime (NYSE: GMR  ) . Business had been going extremely well for these shippers. Freight rates were rising, and demand for shipping services was strong because of a growing global economy and a shortage of ships.

As is often the case, these stocks started to peak out before the eroding economics of the business started becoming evident, but not before investor sentiment had become excessively bullish. Near the top, I remember seeing the various CEOs of many of these companies being interviewed on many of the business television shows week after week. At that time, I thought to myself, "I wouldn't want to be buying these stocks up now."

Sure enough, we started to see the weakening data. Freight rates were coming down, and a shortage of ships that had existed over the prior years was rapidly turning into an oversupply as new vessels were being put into service.

A sinking industry?
Not surprisingly, most of these companies started to report decelerating revenues and profit growth. Investors sold these stocks, and their prices declined even further. Brokerage firms jumped on the bandwagon with downgrades, and more selling ensued. Now, many of these stocks trade 40, 50, or 60% below the level they were a year or two ago.

Why, then, would I like them now?

For exactly that reason.

They're cheap -- not only from a price and valuation standpoint, but from a sentiment standpoint, too. The froth is gone. The decline in the price of their shares has discounted the weaker conditions of their businesses. Lower freight rates have already been factored in, and so has the larger fleet of vessels in operation. More important, perhaps, is the fact that they're not paying attention to the rebound in freight rates recently. Just as investors ignored eroding fundamentals and overvaluation in late 2004 and through mid-2005, so are they ignoring the quiet improvement in conditions now.

Bargains galore
And as I said, by all measures of valuation, these stocks are "on sale." The entire group is comprised of solid companies that have long histories of strong earnings, and they pay very high dividends. General Maritime, for example, pays an 18.4% dividend. It has a 19% earnings yield and a 26% return on equity. Frontline has a 24% earnings yield, a 74% return on equity, and pays a 19% dividend yield. Knightsbridge pays an 18% dividend, has a 10% earnings yield, and has a 20% return on equity.

You rarely see numbers like that, with the exception of the most speculative companies, but these are "old economy" stalwarts and, to some degree, classic cyclical businesses. But don't let that scare you. Buying cyclicals is sometimes the easiest and best investment strategy there is because these companies tend to have long operating histories and predictability in their industries. In contrast, guessing the next blockbuster product or new paradigm is like playing the slots in Vegas. Once in a while, you might win big, but mostly you lose.

The case for shippers
Remember, I told you that brokers were downgrading these companies? Well, you might be wondering why I would want to go against these broker recommendations. The reason, of course, is that brokers are very often wrong, and it pays to fade them.

Look at the recent advice by Jeffries & Co. It downgraded Knightsbridge to a "sell" from a "hold." The stock was at 26 when it did that (now it's at 21). That may seem good to you. But consider the fact that Jeffries upgraded the stock to a hold on Nov. 4, 2004, when the price was 35 and change. It was buying at the top and selling at the bottom. I want to do the opposite of that.

Another theme embedded in ownership of shipping companies is globalization. If you believe in globalization and the global economy (and it's hard to refute it), then I think buying the shippers at these much-discounted levels is an effective yet subtle way to play globalization. Let everyone else chase overhyped and overvalued emerging-market and foreign funds and ETFs. You could get the same exposure with these shipping businesses. In fact, it's better because the shippers tend to anticipate upturns and downturns in the global economy. That means you'll be in before the crowd when the cycle turns back up.

Finally, when I analyzed this group, I couldn't help but think of something Warren Buffett once said when he invested in Coca-Cola (NYSE: KO  ) . He said he liked Coke because everywhere he went people drank it. Regardless of whether he was in the U.S. or traveling around the world, he could find a bottle of Coke practically at arm's length anywhere.

Along the same vein, I like the shippers because it's clear they're not about to pave the oceans over anytime soon. And since planes can't handle the tonnage that ships can, ocean-going vessels face no threat of obsolescence. So there you have it -- a critical industry firmly tied to the expanding global economy that's on sale at a deep, deep discount. Attention, shoppers!

Our very own Admiral, Philip Durell, knows a thing or two about the shipping industry. And he knows value, too. If you also like cheap stocks, try a risk free trial toMotley Fool Inside Value.

Mike Norman is the founder and publisher of theEconomic Contrarian Update. He is also a Fox News Business contributor and a radio host on the BizRadio Network. Mike owns shares in General Maritime. The Fool has a disclosure policy that really holds water.


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