Diana Shipping Inc (DSX) is a global provider of shipping transportation services. DSX specializes in the ownership of dry bulk vessels.
DSX Value Investing Approach
This investment valuation is prepared in a simple and easy way to value a company for business buying, business sell, and business evaluation. This model adopts the investment style of Benjamin Graham, the father of Value Investing. My basis in valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. The financial statement is scrutinized prior to the valuations. In this model, we calculate first the enterprise value as our first step in the valuation. I also apply the relative valuation method by using Price to Earnings (P/E), Earning Per Share (EPS), Enterprise Value (EV) and Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA).
The Investment in Enterprise Value
In valuing Diana Shipping Inc, I performed the Enterprise Value (EV) valuation. The concept is to calculate what it would cost to purchase an entire business. Enterprise value represents the total value of the entire company. It factors liabilities and cash. In other words, EV measures the value of the productive assets or the operating assets that are used in producing its product or services.
Market capitalization, on the other hand, is the total market value of all of the company’s outstanding shares. Computed by multiplying a company’s shares outstanding by the current market price of the share. The total debt represents the sum of short-term debt and long-term debt. Cash and cash equivalent are taken from the balance sheet as well as the short term investment.
In calculating the enterprise value of DSX, total debt is added to market capitalization and cash and cash equivalent plus short-term investment were deducted, then it produces the enterprise value. In buying a company, you do not only buy the equity but you also have to pay for the debt of the company. That is why total debt was added to market capitalization. Cash and cash equivalent plus short-term investment were deducted because this account is not an operational asset, the company is not using cash to generate revenue. Cash could offset debt and can be absorbed by the buyer.
Market capitalization as seen in the table above represents the total value of the company’s equity shares as valued by the market. While, the enterprise value, represents the value of the productive assets or operating assets both equity capital and debt capital. This is the costs of the entire company if you are buying. It shows that the value of the company was diminishing in value from its five years of operation. The total debt represents 27% of the enterprise value, while cash was 24%. EV was trending down at -53, 3, -12, -42 and 12% with an average of -18% from 2008 to 2011 and the TTM. The distribution of the buying price would be as follows:
Average = Total Operating Assets – 100% = Equity – 98% + Total Debt (net of cash) – 2%
TTM = Total Operating Assets – 100% = Equity – 100% + Total Debt – 0%
The enterprise value represents almost 100% equity, total debt has only 2% average. Total debt was offset by cash and cash equivalent, these two accounts were almost equal in amount. If an investor buys the entire business, the investor is paying for the company’s total equity. Enterprise value is trending down by -20% average, while market value is trending at 3% average.
Benjamin Graham’s Stock Test
Net Current Asset Value per Share (NCAVPS)
The concept of this method is to identify stocks trading at a discount to the company’s net current asset value per share, specifically one-third below net asset value or two-thirds of NCAV. This method is one of the oldest documented stock selection methodologies, dating back in the 1930s.
The current assets are basically considered as cash, its liquidity is for a short period of time less than one year. Net current asset value excludes land, properties, and equipment, which is included in book value. NCAV is the excess of current assets over current liabilities. Graham looked for stocks trading for less than two-thirds of the company’s NCAV. The computed 66% of NCAVPS was lesser than the price, therefore, it did not pass the test in buying the stock. Diana Shipping price was over 77% average from the computed 66% of the NCAVPS. The stock price was trading over the company’s liquidity value at 49% over the trailing twelve months. It indicates that the price was expensive.
Market Value/Net Current Asset Value (MV/NCAV)
Another stock test made by Graham is by calculating market capitalization by NCAV and the result should be lesser than 1.2 ratios The result shows the ratio was greater than 1.2, therefore it indicates that the price was expensive. The stock price of DSX shows that it was trading at an overvalued price base on the MV/NCAV stock test of Graham.
Benjamin Grahams Margin of Safety
MOS is used to identify the difference between company value and price. It represents an excess of intrinsic value over market price, or alternatively, a discount of the price below the intrinsic value of at least forty to fifty percent is desirable. MOS requires knowing when the buying price is low in absolute terms rather than merely relative to the market as a whole. This formula is used to identify the difference between company value and price. It represents an excess of intrinsic value over market price, or alternatively, a discount of the price below the intrinsic value of at least forty to fifty percent is desirable.
Enterprise value, in theory, represents the entire cost of a company if someone were to acquire it. Enterprise value is a more accurate estimate of takeover cost than market capitalization because it takes includes a number of important factors such as preferred stock, debt, and cash reserves.
Intrinsic Value = EPS x (9+2*Sustainable Growth Rate
Here is the explanation for the formula: EPS: the company’s last 12-month earnings per share; G: the company’s long-term (five years) sustainable growth estimate; 9: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, but we changed it to 9); 2: the average yield of high-grade corporate bonds.
The intrinsic value of DSX has an erratic movement. In 2008 it was very low but jumped up to 654% in 2009 and trending down by an average of 19% up to 2012 ttm.
The return on equity was 7.99 in the trailing twelve months.
The graph shows that the intrinsic value (IV) line was below the enterprise value (EV) line in 2007, and the point of intersection was in 2008, and it goes up higher in 2009 from $14 to $56.39 with a percentage of 403%. and slightly going down at an average of 19% from 2010 to 2012 TTM. This shows that the enterprise value or the price was lesser than the true value, therefore the price was cheap from 2009 to 2012 TTM. The margin of safety was 77% average over the intrinsic value.
According to Graham, when a market price is considerably lower than the intrinsic value by a minimum of 40-50%, then he would consider buying. It shows that the price was lesser than the intrinsic value by 45% average from 2007 to 2012 TTM. The buying price for the entire company would be $597 at $7 per share of stock.
DSX Relative Valuation Method
This method of valuation is used to compare the market values of the stock with the fundamentals of the stock.
Price to Earning*Earning Per Share (P/E*EPS)
The PE*EPS ratio indicates that the price was higher than the PE*EPS ratio in 2007 and 2008, telling us that the price was trading at an overvalued price. On the other hand, from 2009 to 2011 and the TTM, the price is equal to the PE*EPS ratio, indicating that the stock price is trading at fair value.
By using the average price to earnings ratio in P/E*EPS valuation it produces a higher result than by using the relative price to earnings ratio. The P/E*EPS result was greater than 17% in using average price to earnings ratio. EPS serves as an indicator of a company’s profitability.
Enterprise Value/Earning Per Share (EV/EPS)
Another use of this ratio is by dividing the enterprise value per share by its projected earnings per share (EPS). The price to earnings (P/E) was 40% average, whereas, the price was averaging 60%. On the other hand, using the average price to earnings ratio, the price is 107% and the earnings are -7%. In 2007 to 2012 price was 58% and the earnings were 42%. Based on the relative Price to Earnings ratio, the price was trading at an overvalued price.
Enterprise Value (EV)/Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or EV/EBITDA)
This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings to pay off the price of buying.
Enterprise value is the value of the company. While EBITDA is net income with interest, taxes, depreciation, and amortization. EV/EBITDA tells us the investor will cover up the purchase price in cash in 6 years. However, in TTM, it will take 4 years of the earnings of the company to cover the costs of buying.
The current market price as to date, 8/22/2012 was $7.07 and the margin of safety is 55%. It exceeds Benjamin Graham’s requirement in buying at 40-50% margin of safety. Therefore, I recommend a BUY for the stocks of Diana Shipping Inc (DSX).
Written by Cris