Shares of dry bulk shipper DryShips Inc (DRYS) are up 70% so far in 2012. This rally is even more impressive when considering the Baltic Dry Index is down nearly 50% from the start of 2012.
One potential reason for the divergence between DRYS and the Baltic Dry Index is that DRYS has been trading significantly below book value. Currently, DRYS is trading at just 0.32 times book value. While a discount to book value can be a compelling reason to buy, it has not proven a wise reason to buy DRYS in the past.
Investors could have argued that DRYS was a buy in early 2011 based on its price/book of just 0.45. However, DRYS price/book fell as low as 0.20 in early 2012.
A more important indicator for DRYS stock is the Baltic Dry Index. The level of the Baltic Dry Index determines how much DRYS can change for shipping dry bulk. Historically, DRYS stock performance has been closely tied to the Baltic Dry Index.
In the past, whenever DRYS outperformed the Baltic Dry Index one of two things would happen. Either the Baltic Dry Index would rally and DRYS would move sideways, or DRYS would fall to levels more in line with the Baltic Dry Index.
Right now it is not prudent to buy DRYS because it is much too extended relative to the Baltic Dry Index. A more prudent decision for investors is to wait for a further turn higher in the Baltic Dry Index as a conformation sign to buy DRYS. Even if the Baltic Dry Index rallies sharply, it is possible that DRYS will not move much because it has already rallied significantly. Another possible outcome is that DRYS may fall sharply if the Baltic Dry Index does not move higher. In any event, the prudent decision is to stay on the sidelines for now in DRYS.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.