lessons from economic history

I urge you to read this *lecture (pdf) to the Royal Institute of Naval Architects, given by Dr Martin Stopford of shipbroker Clarksons two years ago. Not just if you're interested in shipping, but economic history and globalisation. It's convinced me to put his acclaimed book on my reading list.

Stopford describes the persistent trend in global development since the 1940s resulting in 50 years of GDP growth at an average annual rate of 3.6% and an average annual increase in seaborne trade of 4.3%. You'd have thought shipping would have been a tremendous business.

In fact the fortunes of shipbuilders, ship owners, and perhaps shipbrokers have been tied to to a long-cycle. It peaked in two bubbles in 1973 and 2009, and describes long periods in the 1980's and the 1990's when earnings from various types of ship were stuck in the doldrums.

It's tempting to quote the text, and reproduce the charts at length, but I shall restrict myself to one quote describing the state of the shipping industry in the years leading up to 1973 because it is such a succinct description of an investment bubble:

By the late 1970's, the independent ship owners were becoming more adventurous and started to order ships on their own account without tying themselves down to a charter. The shipping banks supported them because the ship mortgage came to be seen as sufficient security since ship prices always went up. This broke the link between supply and demand and resulted in a spectacular shipbuilding bubble which peaked in 1973.

The shipping bubble had firm foundations; the end of colonisation and growth of free trade, improved communications, the opening up of new energy sources and financial markets, reconstruction in Europe and the emergence of Japan. By 1973 though there was overinvestment and the oil crisis punctured the bubble.

It took two decades in which ships were scrapped at a fraction of cost before the demand for shipping once again overtook the glut created in the early 1970's.

Replace China with Japan and the oil crisis with the financial crisis and we're in a similar situation in 2009. Stopford believes the globalisation trend has further to run, but we're entering a downswing in the long cycle and the results are likely to be relatively low returns from shipping for the rest of the decade.

That's the awesome backdrop to any decision to invest in Clarksons or Braemar, both shipbrokers.

I don't know if profits from shipbroking are as cyclical as profits from owning or building ships. So far profitability at Clarksons and Braemar has not fallen dramatically, but Stopford's scenario seems to be playing out in Braemar's most recent results. A decline in freight rates resulting from the oversupply of ships, and a subdued sales and purchases market, explain declining shipbroking revenues.

The likelihood we're in a downswing in the long-cycle for shipping, and confirmation that shipbrokers are affected by it, leads me to question whether the 20% or more return on equity Clarksons and Braemar have achieved over the last decade can continue. Since that's the basis for my earnings yield calculation, which makes both companies look very cheap, I'm disregarding it.

Defaulting to book value, Clarksons shares are on a multiple of 1.7. That looks expensive considering the uncertainty and, since I don't like the big bonuses paid to executives, I'm most unlikely to add it to the Thrifty 30.

Braemar, though, is considerably cheaper. The shares cost 1.1 times book value and its diversification strategy may prove prescient.

I prefer to add companies (or remove them) soon after they have published their annual reports, but if Braemar's trading around book value (305p), or better still below it, next May, I'll be tempted.

Curiously, Duncan, aka Kelpie Capital, seems to have come to a similar conclusion.

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* Thanks to John Kingham, aka UK Value Investor, for telling me about it.