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A Dangerous Opportunity

By Anand Chokkavelu, CFA - Updated Apr 6, 2017 at 7:28PM

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The dry bulk shippers offer an interesting investing dilemma.

As an investor who loves a bargain, I salivate when I see a tiny price tag on a stock.

Intuitively, this makes sense. The cheaper a stock's price multiple, the more bad stuff that can occur before your investment becomes a bad one. That's why you frequently hear analysts like me say, "There are certainly problems, but they're priced in already."

But sometimes a stock looks like it has hit rock bottom, only to hit rock bottomer and destroy your investment.

There's an opportunity in the market today that has me considering both scenarios. These stocks are really cheap-looking. But given a historical example, it could be a dangerous opportunity.

The dangerous opportunity
Like a P/E ratio below 10, a price-to-book ratio below 1.0 typically signals market doubt.

Currently, the market has serious doubts about the dry bulk shippers, which transport raw materials such as coal, ore, cement, and grains. Check out the P/B ratios of these major dry bulk shippers.

Company Name

P/B Ratio

Diana Shipping (NYSE: DSX) 0.75
Navios Maritime Holdings (NYSE: NM) 0.49
DryShips (Nasdaq: DRYS) 0.45
Eagle Bulk Shipping (Nasdaq: EGLE) 0.23
Genco Shipping & Trading (NYSE: GNK) 0.21
Paragon Shipping (NYSE: PRGN) 0.21
Excel Maritime Carriers (NYSE: EXM) 0.13

Source: Capital IQ, a division of Standard & Poor's.

Wow, four of the shippers trade for less than a quarter of book value. That appears to be a deal even if they had to close up shop and liquidate. But before we get too excited about these seemingly too-good-to-be true P/B ratios, let's look at an industry that looked just as compelling just a few years back.

Below is a list of the largest public homebuilders and their price-to-book ratios on Dec. 31, 2007. Similar to the dry bulk shippers, homebuilders had seen their stock prices fall to seemingly rock-bottom levels. By then, all but one of them had P/B ratios below 1.0. Some significantly below. Let's see how investors who jumped in have done since.

Company Name

P/B Ratio (Dec. 31, 2007)

Total Return Since Dec. 31, 2007

NVR 2.56 35%
MDC Holdings 0.94 (28%)
Toll Brothers 0.89 6%
Ryland Group 0.87 (40%)
DR Horton 0.74 (4%)
KB Home 0.73 (52%)
Lennar 0.56 11%
PulteGroup 0.52 (31%)
Meritage Homes 0.45 55%
Beazer Homes 0.20 (58%)
Standard Pacific 0.17 5%

Sources: Yahoo! Finance and Capital IQ, a division of Standard & Poor's.

Given that the S&P 500 has been pretty much flat after accounting for dividends, the seemingly cheap homebuilder industry has been at best an "eh" proposition. We see two winners, five losers, and four relatively flat stocks.

Also notice that there doesn't seem to be a correlation between lower P/B ratios and better returns. In the most extreme case, NVR was more than twice as expensive as any other homebuilder. Yet it ended up with the second best total returns.

There are two related lessons here:

  1. Low P/B ratios can be deceiving.
  2. Sometimes expensive beats cheap.

Applying these lessons to today
We know what happened with the homebuilders. As the housing bubble continued to burst, the houses the homebuilders held on their books didn't prove as valuable as was believed at the end of 2007. Their P/B ratios were artificially low.

At their highs, American home prices were 1.47 times today's prices. Think of the havoc that price volatility wreaked and then view this statistic on dry bulk shippers.

In 2008, the Baltic Dry Index, a measure of how much the shippers can charge, was 8.87 times today's price!

That's what makes assessing the opportunity in dry bulk shipping so dangerous. Because shipping rates change so violently (due to factors including recent oversupply, oil shocks, and the price of the commodities they ship), predicting the future contract terms (and hence earning power) of a shipper's ships is very difficult. Like the homebuilders before them, the book value of these shippers is only as good as the income their assets can produce.

Furthering the lessons from the homebuilders, the most expensive shipper, Diana, may be cheaper than it looks. While most shippers employ sizable amounts of debt that increase bankruptcy risk, Diana has a net cash position -- i.e., more cash than debt. Diana could well be this group's NVR.

That said, be careful out there. I do believe there is some opportunity in shipping for the intrepid, but these waters are choppy. As you do your due diligence, don't be lulled by the siren song of just one or two too-good-to-be-true numbers.

For some less dangerous opportunities (at least according to our analysts), check out our free report that details five stocks The Motley Fool actually owns. The last stock write-up is mine. Click here to access it now. It's free!

Anand Chokkavelu doesn't own shares of any company mentioned and is mostly a landlubber. Motley Fool newsletter services have recommended buying shares of MDC Holdings and Meritage Homes. Motley Fool newsletter services have recommended shorting Standard Pacific. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

DryShips Inc. Stock Quote
DryShips Inc.
Eagle Bulk Shipping Inc. Stock Quote
Eagle Bulk Shipping Inc.
$49.46 (-1.26%) $0.63
Genco Shipping & Trading Limited Stock Quote
Genco Shipping & Trading Limited
$15.88 (-1.79%) $0.29
Diana Shipping Inc. Stock Quote
Diana Shipping Inc.
$5.36 (-2.19%) $0.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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