September 15, 2003
Don’t Believe The Bull Market Baloney

Vulcan Materials - America’s biggest supplier of construction aggregate (crushed stone, sand and gravel) – is a well managed company that has a somewhat attractive dividend yield of 2.33%. The company consistently generates free cash flow (or the cash that is left over after expenditures and dividends are subtracted from Cash from Operations), and its primary assets – quarries/stone reserves – are, in many cases, protected by barriers of entry. Beside construction materials the company’s other dwindling interest, in chemicals, has historically proven to be less predictable (at least with regards to margins), and oftentimes unprofitable business segment.     

Suffice it to say, if you are in search of a turnaround story – or a company that will benefit from a sustainable economic recovery in the United States – you could do worse than Vulcan Materials. More on this in a moment.     

Bull Market Banter

To better understand the type of investment approach being deployed by fund managers and market chasers today, consider a comment from the ever optimistic Larry Kudlow, made recently in article entitled ‘The New Economic Reality”:

“Stock market multiples will continue to expand. Animal spirits will keep rising.”

Incidentally, the sub title of the above article is ‘When will bears wake up and smell the coffee?’, or the same question – changing the word ‘bears’ for ‘Kudlow’ – anyone with common sense has been asking Larry since early 2000.  But I digress. 

What Mr. Kudlow is arguing, and what a continued rally in stocks would confirm, is that market multiples will escalate because stocks are in a new bull market. In fact, Kudlow doesn’t mince words -- “We’re in a bull market. It has legs”.

Not to be left out, over the weekend James Glassman offered some bullmarketspeak of his own:

“If you're not in the stock market when the surges occur, your portfolio won't recover the losses it suffers during the downdrafts.” 

Similar statements from Mr. Glassman were ridiculously timed when uttered last year and the year before…but today, since prices are rising strongly, his comments appear beautifully prescient; exactly what anxious equity gamblers want to hear.

Suffice it to say, the bull market slogans being touted today are no different than those being lauded leading into 2000.  In fact, one of the longest bear markets ever is being regarded – for those that believe it is over – as nothing more than a giant ‘buy the dip’ opportunity.  Remarkable.
 
Lastly, consider an article from the Financial Post -- ‘Never mind the 'value,' feel the momentum’. This article, catering to (and also poking fun at) the day trading/tech dreaming crowd, concludes, “As long as you know that (the current tech rally will end in tears) and have an exit strategy, welcome to the Nasdaq techs”.  Why FP’s William Hanley didn’t simply say ‘trade tech stocks with a stop loss’ and end it at that is unknown. Instead, the reader is treated to discussion about why tech stocks are absurdly overvalued and destined to crash, but also why investors with an ‘exit strategy’ should embrace overvaluation and plan to profit while avoiding the crash. Not surprisingly, how many hit stop losses a tech gambler can take before going either insane or broke is not at all mentioned...

Suffice it to say, when investors begin to pay more for stocks the commentators and analysts come crawling out of the woodwork to pay homage to how their overly optimistic investment platforms have (and can continue to) reap(ed) profits. The Kudlow’s and Glassman’s - seemingly impervious to the fact that they continue to offer bullish antidotes for terrifically overvalued stocks – are transforming from villains to hero’s as they joke about the pessimistic bears that missed out on RALLY 2003. Remarkable. 

Will The Run in Stocks Be Vulcanized?

Despite numerous definitions of a bull market – i.e. a rally of 20%, higher highs and lower lows, etc. – the most astute definition is the obvious one offered by Kudlow: multiples rise in bull markets. Remember, bull markets do not occur as a result of countries adopting sound monetary and fiscal policies, nor are they necessarily based upon tangible increases in profits and/or shareholder wealth. Rather, in bull markets stock market multiples rise simply because investor’s, sometimes for reasons unbeknownst to anyone, are willing to pay more for each share.

On February 3, 2003 Vulcan was forecasting EPS of $1.85-$2.15 in 2003, on April 29 Vulcan was expecting EPS of $1.85-$2.15 in 2003, and on July 28 Vulcan was expected EPS of $1.85-$2.05 in 2003. Despite the lower top-end estimate made in late July, VMC’s EPS estimates have remained largely unchanged all year -- VMC’s stock price has not (investor’s pay more in a bull market!).


Yes, if you are in search of a turnaround story – or a company that will benefit from a sustainable economic recovery in the United States – you could do worse than Vulcan Materials. However, VMC’s share price has already benefited – beyond what can be considered rational price appreciation - before such a turnaround has arrived. To be sure, VMC traded at 36, 34, and 32 times free cash flow at the end of the last three years respectively -- today Vulcan is trading at roughly 42 times free cash flow (assuming the company’s stock price and free cash/dividend estimates hold firm until the end of this year).

In sum, the current rally in stocks is baloney because it caters to (and is supported by) investor’s that think they can ‘feel the momentum’ and recoup their losses following the ‘downdraft’. Quite frankly, saying that these ‘animal spirits’ will continue to propel stocks higher - that the VMC’s are a screaming buy at any price - is extremely dangerous. VMC is not a screaming buy unless you know the company is vastly underestimating expectations. Arguing that VMC is a buy for any other reason - or to ‘believe’ investors will simply pay more for each share - is to play the part of the greater fool.

Trillions of dollars in stock market wealth was lost between March 2003 and October 2002 because fools rushed in, and gamblers stopped ‘believing’...


No one at FallStreet.com has any investment position in VMC.

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