Thursday, October 09, 2008

The Plunging Baltic Dry Index And The Dangers Of Using Forward PE!

And the Baltic Dry Index plunged yet again!

Other postings on the Baltic Dry Index:

1. Views On Current Weakness On Baltic Dry Index
The Collapse of the Baltic Dry Index
Goldman Downgrades Bulk Shippers!
Baltic Dry Index Keeps Falling!
Baltic Dry Index Stages Strong Rebound!
Baltic Dry Index Set For Strong Recovery???
Baltic Dry Index Plunges To Seven Month Lows!
The Baltic Dry Index Keeps On Plunging!
Baltic Dry Index Continues To Plunge

This morning I read a good passage loaded on Seeking Alpha on investing in the baltic dry index. It's a short investing lesson, a rather important investing lesson on using forward PE.

Anyway here is the article.

Never enough lessons on forward P/E, especially for cyclicals. On Tuesday, dry bulk shipper DryShips (DRYS) hit an all-time low of $21.8, down from a peak of $120, and down from the $64 back when Barron's called the Buy on the stock. Everyone is wrong at times, and being wrong for decent reasons is fine. But in a previous post in April, we outlined that we mostly took issue with Barron's completely missing some of the most important issues with dry bulk commodities transportation stocks such as DRYS, and worst of all arguing for the stock given a very low forward P/E, which was completely ridiculous given that the bulk shipping industry is prone to earnings swings of +/-80% within short, unforeseeable periods of time. The below was our previous excerpt from Barron's:

  • Global trade might slow this year, but it will come back eventually, and DryShips' profits -- and shares -- should move up over the long term, even if 2008 growth turns out to be lower than Wall Street expects. At its recent quote of 64, DryShips stock was trading at a price/earnings ratio of 3.5 times consensus analyst earnings estimates of $18.18 a share this year and about 5 times the $12.22 forecast for 2009. DryShips also trades at a more than 50% discount to its peers, although rivals generally seek long-term contracts, which are less volatile.

And then our following criticism.

  • This article fails to mention that dry bulk spot rates are extremely volatile and forecasting where they will go is subject to massive room for estimation error, even for industry veterans. Thus forward P/E can be very deceptive and is a silly way to look at the companies. Last year Clarksons research surveyed a large collection of readers to forecast where rates would go in 2007 and EVERYONE was wrong by a large margin. (they spiked massively) They can also spike massively downward in the same fashion... If forward earnings ends up being 80% lower, which historically isn't a crazy notion at all if you look at a rate chart, your P/E will be 5x what you thought it was. Thus using forward P/E is pretty silly given its forecast error range is so wide as to be near meaningless.