A valuation ratio at a point in time does not say much about a company’s investment attractiveness; it is like getting a score for the number of times a batter has hit a home run for the day without looking at what was done in the past or comparing to others. Likewise, it is important to see how valuation ratios have changed and how expensive or cheap a stock is compared to others.
The market’s perspective
On May 6th, the Diana Shipping Inc. (DSX) enterprise value to sales multiple (trailing twelve months) stood at 3.68x.1 The multiple has gone through an uptrend since September 12th as share prices rose, suggesting the market is becoming more optimistic with the company’s future outlook and is willing to pay more for the company’s historic sales.2
On a relative basis, DSX looks cheaper than other companies, such as Safe Bulkers Inc. (SB), Navios Maritime Partners LP (NMM) and DryShips Inc. (DRYS). Valuation for DSX has been falling from 2011 to mid-2012 because a large portion of the company’s contracts were maturing, forcing DSX to recharter at market rates that were lower than previous shipping rates that was driven by industry oversupply. As DSX’s contracts mostly reflect current markets and shipping rates look to be stabilizing, DSX’s revenue will unlikely fall substantially further (see Why Diana will outperform Safe Bulker and Navios Maritime).
The EV to Sales multiple
DSX’s enterprise value to sales is also depressed because the market is not reflecting the fact the company has almost no net debt. While investors often use ratios, such as price to sales and price to earnings, because of their popularity, the ratios do not consider the total capital that the business is using to generate revenue.
Suppose two companies both generate $1,000 each in annual revenue, with a market cap of $1,000. Company B, however, also has $1,000 in debt to operate its business. The total business purchase value for company A is $1,000, but $2,000 for company B. Company B is then more expensive than company A.
To reduce exposure to company specific drivers, investors can alternatively consider the Guggenheim Shipping ETF (SEA), which invests in a basket of the largest shipping companies worldwide.
- Enterprise value to sales multiple (EV/Sales) is a common valuation metrics used by analysts to value a company. While often used to value companies with no earnings, the metric can be used to analyze companies with similar cost structure, but with differing revenue contracts due to contracts of different lengths. ↩
- The basic formula for calculating enterprise value is market cap + net debt + preferred shares + minority interest. ↩
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