Customer Reviews

Active Value Investing: Making Money in Range-Bound Markets (Wiley Finance)

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One of my only posts because few are so bad that they compel me to write a review.

This is easily the worst book on investing I've ever read. I actually experienced a sense of agony in reading this book knowing I could be reading something better. It should not even be called a value investing book.
The author suggests finding companies that have low P/E's, that are fundamentally sound. He gives a very brief, useless description of what soundness is and is not. In fact his method for determining a stock's value as a whole is very shallow. I felt like he is just a journalist describing the surface of things. He mentions nothing of where to find a companies fundamentals, but briefly describes how they should look "strong, good, upward-trending", etc.

The worst of all is that I have a firm suspicion the he had his close friends and colleagues give him such high reviews. For example take a look at all the reviews. Most read just like the editors review of the book. Very long and touting promise. Next he gave the book to several of the reviewers and asked them to review it. They actually mention that in their reviews. The result being that all the longer reviews sound the same as if he gave them some press release to put their own spin on without reading the book. And lastly, a good number of reviewers come from the city where he teaches at, Denver. Most likely associates of some sort just doing him a favor.
If you think that unlikely, Google the book. You'll find the same reviews of the book from Amazon on other investors websites.

Bottom line. Don't buy this book. I'll be putting mine on here for .01 cent if you really must have it.

Anyone fortunate enough to have invested during the bull market that began in 1982 will find easy to say "buy and hold forever." Indeed, for almost twenty years, the market had one general direction - up, and anyone who bought and forgot did well for nearly 18 years. Warren Buffett has described the bull market that began in 1982 as a period unlike any other for the markets and that it is highly unlikely or quite some time before the U.S. markets experience that again. And although Buffett is famous for his "our favorite holding period is forever" line, it wasn't until later in his investing career - when Berkshire's capital was enormous - that this approach really made the most sense for him and Berkshire Hathaway.

Consider that from 1983 until 1999, the average annual return on the S&P 500 was 15.7%, assuming the reinvestment of dividends. A similar return like this for the Dow Jones beginning in 2008 would mean that the Dow would be trading over 139,000 in 2024!

It is in this context that I found Active Value Investing: Making Money in Range Bound Markets by author and portfolio manager Vitaliy Katsenelson an interesting and insightful read on understanding the long mood swings of Mr. Market. One should not assume that the word "Active" in the title to suggest market timing - this is the last thing Vitaliy is concerned with. In fact he readily admits that trying to time the market is a fools game. Instead his focus on using fundamental valuation techniques - discounted cash flow analysis, price to earnings models, and margin of safety - to take advantage of range bound markets.

Any serious participant in the stock markets is well aware that markets trade in in ranges some periods longer than others. During the 16 year period beginning 1966 and ending in 1982, an investment in the Dow Jones index in 1966 would have been worth about the same sixteen years later. Hovering around 1000, the Dow remained around 1000 in 1982. Whatever dividends you earned were wiped out by inflation during that time. A simple buy and hold approach during that time would have produced an annual rate of return of zero percent. Yet during that sixteen year period occurred one of the most opportunistic buying opportunities in the U.S. Beginning in 1974, as Buffett so famously quipped, "I was selling at 3 times earnings to buy stocks at two times earnings."

Active Value Investing discusses how the prudent use of fundamental analysis allows to take advantage of such opportunistic times in the market. Focusing on the only three variables that really matter in a business - value, quality, and growth - investors can learn how intelligently exploit Mr. Market's mood swings. Unlike most great investing books that are focused on the buying process, Active Value Investing takes a very close examination of the selling process, something I find to be the most misunderstood area of investing. Make no mistake, if you can't buy at the right time, knowing when to sell won't mean much. Not only does Vitaliy walk you through his framework of knowing when to buy stocks, but he also takes a deep look at selling stocks, a topic not given enough discussion among value investors. Active Value Investing looks to change all of that.

We all realize that the markets are never a smooth ride and that market timing is mere folly. The key to taking advantage of the market's swings - buying on the stalls and selling on the surges - is to focus on valuation of individual securities. Indeed it is the price in which you buy that ultimately determines your return when you sell. Understanding what to look for in businesses and how to value them is an absolute must if you hope on succeeding in the markets for a meaningful period of time. Active Value Investing helps steer you in the right direction.

Vitaliy Katsenelson's book is written in three sections: a background section, a section on active value investing strategy, and a section on applying his active value investing strategy. It's quite a friendly read which any reader with a basic knowledge of investing terms could make sense of and learn from it. The writing style is colloqial however, and the author uses pop culture references to illustrate his points. An example of bad taste is a paragraph that attempts to use Steve Irwin's tragic death as an analogy for risk and risk management strategies.

Despite these qualms, the content of this book has shining moments. The Active Value Investing strategy, while not necessarily novel, puts together many important lessons on investing in a very simple and understandable way through his QVG (Quality, Valuation, and Growth) framework. The author uses simple metrics like "P/E" to build a framework for analysing companies. In view of the recent accounting irregularities associated with the "E" in P/E, however, this one dimentional metric may be too simplistic for anybody but the most novice investor. Still, it's a start.

The last third of the book shares with the reader a lot of the author's own thoughts on buying, holding, and selling stocks. Probably the most interesting chapter to see was a chapter on "selling" and how to develop a strong sell strategy. (Useful for traveling salespeople)

Two portions of Vitaliy's book - his active value investing strategy and his various chapters on practical application - would probably be enough for a strong entry into a sea of investing books usually heavy on promises and light on actual content. Basically, the author's idea is that markets typically have two long-term "trends" and they are not bull and bear. Instead, he believes there are bull markets (the last of which finished in 2000) and flat, range-bound markets. Between 1960 and 1980, major indexes moved up and down and up and down but over the entire twenty year period there was little or no appreciation in either the Dow Jones or the S&P 500. He believes that in 2000, we started yet another one. His chapters on range bound markets are interesting and provide some very enlightening analysis of the psychology which drives long-term trends in the markets.

All-in-all, Active Value Investing: Making Money in Range-Bound Markets is an enlightening book for anyone starting out in investing. That said, some of the writing can drag and Vitaliy's strategy may feel a bit "dumbed down" for more experienced investors. Furthermore, statistically a passive index has been found to beat active investing around 60% of the time, going back to the turn of the last century. A better book on investing would be Jeremy J Siegel's "Stocks for the Long Run".

As you may have noticed, there is a new value investing book out. It's called Active Value Investing: Making Money in Range-Bound Markets by Vitaliy N. Katsenelson. In the spirit of full disclosure, I want to mention that Vitaliy is sponsoring this month's contest at ValueInvestingNews.com, where we are giving away three free signed copies of his book. Acknowledging this potential bias, I've tried to be extra critical in my review of this book.

Who is Vitaliy Katsenelson?
Vitaliy is a CFA charter holder and a portfolio manager with Investment Management Associates. He has been involved with the investment industry since 1994. Vitaliy is also a fellow value investing blogger at the site, ContrarianEdge.com. I give authors more credibility when they are willing to expose themselves to public comments and debate by having a blog.

In addition to his portfolio management work and writing, Vitaliy also teaches at the University of Colorado at Denver. He teaches an interesting sounding class called Practical Equity Analysis and Portfolio Management. You can tell that Vitaliy has teaching experience from his clear writing style and good use of examples in Active Value Investing.

Vitaliy's life is another example of the American dream come true. He grew up in the Russian city of Murmansk during the Cold War, overcame his bias against the United States, immigrated with his family to the U.S., earned bachelor's and master's degrees from the University of Colorado at Denver, and now has a successful financial career. It is a very impressive story that I'm sure gives Vitaliy a unique perspective on life. I enjoyed reading Vitaliy's story in the Acknowledgements section of Active Value Investing. It's at the last few pages of the book, so be sure not to miss it.

Why you should read this book?
First off, Vitaliy is keenly aware of the audience for his book. Value investors are a skeptical lot, and Vitaliy immediately sets about mentally disarming this tough audience. I chuckled when I read the imagined Q&A session with the "Skeptical Reader". I was more than willing to step into the role of the skeptical reader. The Q&A session did a good job of answering my questions about what is active investing, what is a range-bound market, and what I can do to address this market challenge. After this short section, I was motivated to read more.

Are we in a "range-bound" market?
Part I of Active Value Investing examines whether we are in a "range-bound" market. Vitaliy starts this section with a warning, "Fasten your seat belts and lower your expectations," and sure enough my expectations did drop a bit. Not to worry though, my expectations rose again after page 72 of this 282 page book and it definitely became a worthwile read.

The first 72 pages of the book takes you through a detailed statistical history of the market to support Vitaliy's thesis that we are in a range bound market. Like many other recent pieces on historical market performance, this part of the book relies heavily on Yale University professor, Robert Shiller's data. I must admit that I'm not much of a fan of historical market analysis and I've seen similar research elsewhere, so it was hard for this section to keep my interest. However, the paragraphs on the Japanese bear market (pg. 27-29) did pique my interest, and this discussion helped explain the difference to me between bear and range-bound markets.

Even though I struggled a bit to get through this part of the book, I definitely came away believing that there is a lot of evidence to support the possibility that we are in a range-bound market. My problem might have been that I was convinced too quickly. If you are anything like me, I recommend that you skim through this Part I of Active Value Investing once you are convinced that we are in a range-bound market.

How do I become an active value investor?
Part II of Active Value Investing was much more to my liking. It sets out to teach you how to be an "active" value investor. Vitaliy does this by detailing his quality, valuation, and growth framework. I found this to be an excellent approach to analyzing stocks.

In Chapter 5 on quality, I was especially excited to see a section on competitive advantage. I found it interesting that Vitaliy focuses on the importance of sustainable competitive advantage similar to the way I do, and uses the same term for it that I use. I know that Buffett uses the term "durable competitive advantage", and I've seen a few other variations elsewhere, but I prefer focusing on "sustainable" competitive advantage. To further illustrate what sustainable competitive advantage is, Vitaliy provides a great discussion on brands using several good examples to make his point. I had a similar discussion on brands back in October of 2005 in a post about brands versus franchises.

I also found the discussion on debt to be very enlightening. Vitaliy notes how stock buybacks distort the apprearance of the balance sheet and can result in debt-to-asset or debt-to-equity ratios that are misleading. I had never thought about this issue before, and I have been primarily using debt-to-equity ratios in my analysis, so I found this discussion to be extremely valuable. Instead of using the debt-to-equity ratio, Active Value Investing recommends we utilize the debt/EBITDA, debt/operating cash flows, EBITDA/interest expense, and operating cash flows/interest expense. I'll be definitely relying on some of these other ratios a bit more in the future. Vitaliy followed up this discussion on debt with an illustrative case study of Colgate-Palmolive's capital structure. This is one of the strong points of Active Value Investing, the book includes many good examples to help the reader understand what a concept really means. Vitaliy fully explains how sustainable competitive advantage, high-quality management, predictable earnings, significant free cash flows, strong balance sheet, and high returns on capital are some of the main elements that help determine quality.

Growth is also an important element of active value investing. Vitaliy uses a flipped growth pyramid to explain the drivers of growth. He lays out the primary strategies companies use to grow revenue and then goes on to talk about growth from margin improvements from operating efficiency, economies of scale, and stock buybacks. Vitaliy includes a good case study of Westwood One's share buyback, which illustrates how share buybacks can destroy shareholder value if done improperly. This section on growth concludes with the topic of dividends and their relative importance in a range-bound market.

Valuation is at the hear of active value investing. Vitaliy does an excellent job explaining the concept of discounted cash flow analysis using the story of Tevye the Milkman. Tevye's cow, Golde, and her various cash flows are cleverly illustrated. I know I will be using this graphic in the future when I'm asked to explain discounted cash flow analysis. One unique concept introduced, was the absolute P/E model. The absolute P/E valuation method uses a schedule of expected EPS growth rates and, dividend yields to adjust a base P/E value level. This multifactor P/E model seems practical but relatively untested in my mind. I'd be interested in talking to Vitaliy in ten years to see if he still uses it. Regardless, it still might be interesting to compare the results you get with more traditional discounted cash flow models with this absolute P/E method of valuation to see how close your results come out.

I highly recommend that you read Chapter 12: Sell Process - Make Darwin Proud, if you read anything in this book. This chapter was a wake-up call to me. I don't have a really good sell process and the one Vitaliy presents is very logical and seems to be the key to acheiving good investment performance in a range-bound market. Vitaliy recommends setting a P/E target level right away to determine when to sell a stock. He even suggests using a stop-loss strategy after a stock reaches its fair valuation. I've started using this particular strategy.

Finally, I also recommend reading chapter 13 on risk. If you are new to the topic of risk and randomness, this chapter will be a great introduction for you on the topic. He breaks the concept of randomness into two components: the level of uncertainty and the significance of impact. I am a big fan of Steve Irwin, the Crocodile Hunter, and I think Vitaliy did a great job discussing the role of randomness on Steve Irwin's life.

In summary, I think there is a lot of substance to Active Value Investing. The first few chapters might turn off some (market history buffs might love it), but the second half of the book is a real gem. If you are new to the concept of value investing, you will learn a tremendous amount from the clear and instructive writing. Even if you are a seasoned value investor, you will find several unique concepts and new ways of looking at value investing.

2007 Wiley Finance, 295 pages (of which 256 pages form the main body of the book).

Before I start this review, you should know that I didn't just buy a copy of this book, read and then review it (as I've done with all my other reviews). The author (who I'd not come across before) contacted me, asked if I would review his book and supplied me with a copy. As it was endorsed by Nassim Taleb and James Montier, I thought it might be worth reading.

I was a bit sceptical of the book's title: surely value investing is value investing and the 'active' bit must be a gimmick? After reading the book I've come around, mainly won over by the extensive and very interesting statistics. Apart from the book's value in providing revision and reinforcement of the key value investing principles, it presents two particularly useful ideas. The first is that average stock market returns don't happen very often and the second is Katsenelson's multi-input PER (price/earnings ratio) model.

The first of these points is Katsenelson's main thesis: very long term (100 years+) average stock market returns (in the US) comprised protracted periods of above average returns (bull markets) followed by similarly long periods of below average returns (what Katsenelson calls 'range-bound' markets). I like the way the author puts it:

"...investors expecting the average returns observed over the past century are likely to be disappointed, as average happens a lot less frequently than we've been told."

This brings us to the most useful part of Katsenelson's book. His examination of data going back through several of these long-term cycles shows that economic growth, interest rates and inflation didn't explain the different returns in the periods of above average vs. below average returns. It was the starting valuation (PER) that mattered. The expansion or contraction of the market PER was responsible for virtually all of the difference in returns (with the exception of the Great Crash of 1929-1932) in the different market phases over the past century. I found this extremely interesting: I knew valuation mattered a lot, but I didn't know it was likely the only thing that matters (short of utter disaster).

Following on from this, Katsenelson attempts to show where we are in the cycles of above vs. below average returns (fortunately he understands that the most one can say at any point in time is that a certain outcome has a higher probability than other outcomes). I liked the way he approached this. Rather than using only, say, the one year historic PER, he presents the data in different ways: using the one year trailing PER and then also using the three, five and ten year average trailing PERs. This provides a useful sensitivity analysis to adjust for the current extremely high return on equity in the US and also allows us to draw our own conclusions if our opinion differs from that of the author (I think this is a great idea).

His analysis shows that we are very likely within a range-bound market that started in 2000, leading to two important practical investment considerations. The first is that dividends are critically important: they accounted for 90% of the average 5.9% nominal annual return during the range-bound markets Katsenelson has identified over the past century! The second is that being fully invested is much less important than in bull markets because, though the market fluctuates significantly in range-bound markets, the fluctuations cancel out.

Mohnish Pabrai comes to the same rejection of the long-term buy and hold approach in The Dhandho Investor from the perspective of seeking the highest possible returns (without reference to the market). Katsenelson, however, believes that only substantial outperformance will produce satisfactory returns owing to the overall market's likely poor returns. Thus they both agree that an investor has to learn to sell (which many super-investors, including Marty Whitman and Joel Greenblatt consider very difficult or impossible to do well). Interestingly, Pabrai and Katsenelson both agree on the general principle: that you should have your exit plan in place before you invest.

This brings us on to Katsenelson's multi-input PER model, where he suggests using a simple PER model that adjusts an 'average' PER for such factors as growth, business quality, financial risk and dividend yield. I think this is a very good idea and is something I intend to try out.

I didn't like all of Katsenelson's book. For example, I found his effort to explain discounted cash flow analysis, using Tevye the milkman and his cow, somewhat confusing and I spotted a higher number of errors than normal (though I'm not sure if I was emailed the final version of the book).

The author's general conclusions about future US stock market returns have also already been presented by Warren Buffett in two articles published in Fortune magazine in 1999 and 2001 entitled "Warren Buffett on the stock market", both by Carol Loomis.

Buffett and Katsenelson differ in their view of the importance of interest rates in affecting historical returns and Katsenelson (necessarily, as his is a book) presents considerably more detailed statistics. I'm also not sure that Buffett would believe that most investors would obtain any benefit from efforts to turn over their portfolios faster (the vast majority of investors have the opposite problem - as Katsenelson himself shows when he quotes a study showing the absurdly awful returns mutual fund investors actually achieved compared to the overall market in the 19 years to 2002).

So, where does that leave us? With a book containing some good ideas and excellent data and statistics but with a central conclusion (do more selling) that I suspect most investors will simply find too difficult to do well (notwithstanding Katsenelson's advice on how we might do so). Problems that originate from our psychological biases are very difficult to deal with satisfactorily: sometimes our efforts to improve (returns) can have the opposite effect.

The beginning of this book explores the idea of a "range bound market." We often forget that stock markets can go long periods of time without going up. One example of this is the range bound market from January 1966 until October of 1982, a period when the total return of the Dow was 0, despite rising and falling a lot within that period. Range bound markets often happen when, despite earnings growth, there is a P/E contraction. Katsenelson spends the first few chapters explaining range bound markets, and arguing that we are in, or about to enter one.

The second part of the book looks at the QVG - quality, value, growth - framework for analyzing stocks. If you are already a student of value investing, most of this will be review for you. Katsenelson puts more value on growth than the average value investor, but I think that's fine, as it can result in stock picks that have an overall higher quality, instead of the kind Warren Buffett calls "cigarette butts," meaning they just have one good puff left.

The third part of the book looks at investment strategy and covers the buy process, the sell process, and international investing. The best part about this book, in my opinion, is the chapter on the sell process. When to sell is a problem for many value investors, as so much of the educational material is focused on when to buy. Yet, it a proper decision making process for when to sell is important, because buy and hold can be a lousy strategy in range bound markets.

The fourth and final section of the book has to do with risk and diversification. Like most value investors, Katsenelson is skeptical of beta, pointing out that risk really stems from ignorance. He advocates a small and focused portfolio that is large enough not to kill you if you make a bad decision, but small enough that you can really follow and continually analyze the companies you own.

Overall, I think this book is one of the top 3 books on value investing that I have ever read. It's clear, a little bit humorous, and has excellent examples to reinforce the points made in the text. It will serve well as an intro to value investing, or as a more in-depth study for the experienced value investor.

This is a fine addition to any investor's bookshelf.

On first reading, I thought it decent, but a bit shallow. But it has one of the best, and most accessible, discussions of how to value a business I've ever read. Many times I've used similar "thought experiments", attempting to reduce the complexities of publicly traded companies' financials to simple, but realistic examples, like Vitaliy does with "Tevye the Milkman" and his cows.

It was sometime after that initial read, and while I was re-reading selected sections that I realized this is a VERY GOOD book. And now, in that way we all have of simplifying concepts, when people ask me about my investment perspective, I kind of just point to Vitaliy. "He says it best." I counter that deification by keeping the book on top of the toilet.

Aside from the character Tevye, the main take away for me is about when, and why, to sell. Vitaliy makes a convincing case that we are destined to spend decades in range-bound markets, especially after long bull runs like the end of the 20th century. But from the inside, the ranges are large enough that we don't really see it, but instead experience it as separate bull and bear markets. The difference is that by the end of the long range period, there has been no net progress. Knowing that in advance, being able to see "outside the range", seeing the box we're in for what it is - that's what this book is about.

Active Value Investing has the hallmarks of all great investing books - easy to read, humorous at times, and most of all it demonstrates Vitaliy's investing process in terms accessible to the novice and expert alike. Despite it's title, this book is for bull, bear, or range-bound markets and will be highly recommended to our newsletter subscribers. I should add that I know Vitaliy personally and frequently discuss investing ideas with him - he's sharp, obviously knows his stuff and has that driving enthusiasm necessary to be a successful money manager.

When you read the book you'll see what I mean

Philip Durell
Advisor
Motley Fool Inside Value

The notion of buying stocks for the long run, or buy and hold, is so drilled into most value investor's heads, that few question whether it is always the right strategy. Katsenelson effectively outlines that some markets, in particular, range bound markets, are not an environment in which to blindly buy and hold stocks.

What is unique to this investment book is how Katsenelson illustrates the history of range bound markets and the low returns to investors during these periods. Since most of today's investors only know the feast and famine of the tech bull and subsequent bust, I think they will find the notion of range bound markets, which have extended for 10 or 15 years at a clip, to be an eye opener. The charts and graphs of how this has played out over the past century cannot be found in any other investment book I have read.

After spelling out its theory, the book turns practical and outlines how stocks should be bought and then unlike most investment books, it addresses how to sell stocks, too. I believe it is well worth a read and the charts and graphs alone are worth the price of the book.

From the description, I thought that Katsenelson had found an innovative new approach to investing. My mistake.

His big original insight in the book is that, if market indices stay in the same small range for years, then you can't make money buying and holding index funds. Katsenelson manages to spend 60 pages on this topic, even though it seems too obvious for that to be possible.

The second part is a fairly standard stock investing primer. It covers the basics of value-based analysis, the clever idea of selling when a stock is no longer undervalued, diversification, and 9 pages on international stocks. None of this is anything that isn't covered in many other basic investing books.

For someone who is new to stock investing, I could see this being a useful book. Even there, however, there are much better organized books targeted towards to beginners. To someone with an existing knowledge of fundamental analysis, this book has very little to offer.