Shares of dry bulk shipper Diana Shipping Inc (DSX) are up 14% so far in 2012. This rally is impressive when considering the Baltic Dry Index is down nearly 50% from the start of 2012.
One potential reason for the divergence between DSX and the Baltic Dry Index is that DSX has been trading significantly below book value. Currently, DSX is trading at just 0.59 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 DSX in the past.
Investors could have argued that DSX was a buy in early 2011 based on its price/book of just 0.85. However, its price/book fell as low as 0.51 in early 2012.
A more important indicator for DSX stock is the Baltic Dry Index. The level of the Baltic Dry Index determines how much DSX can charge for shipping dry bulk. Historically, DSX stock performance has been closely tied to the Baltic Dry Index.
In the past, whenever DSX outperformed the Baltic Dry Index one of two things would happen. Either the Baltic Dry Index would rally and DSX would move sideways, or DSX would fall to levels more in line with the Baltic Dry Index.
Right now it is not prudent to buy DSX 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 confirmation sign to buy DSX. Even if the Baltic Dry Index rallies sharply, it is possible that DSX will not move much because it has already rallied significantly. Another possible outcome is that DSX 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 DSX.