The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere (Little Books. Big Profits) [Hardcover]

Vitaliy N. Katsenelson (Author)

Book Description

Publication Date: December 7, 2010 | Series: Little Books. Big Profits (Book 32)

"It's hard to talk clearly about investing and make sense to ordinary readers at the same time. Katsenelson gives a lucid explanation of today's markets with sound advice about how to make money while avoiding the traps that the market sets for exuberant bulls and frightened bears alike." -- Thomas G. Donlan, Barron's

"A thoroughly enjoyable read. Provides a clear framework for equity investing in today’s ‘sideways’ and volatile markets useful to everyone. Clear thinking and clear writing are not often paired - well done!” -- Dick Weil, CEO, Janus Capital Group

"The bible for how to invest in the most tumultuous financial market environment since the Great Depression. A true guidebook for how to build wealth prudently.” -- David Rosenberg, Chief Economist & Strategist, Gluskin Sheff + Associates Inc.

"A wonderful, grounded read for new and seasoned investors alike, Katsenelson explains in plain English why volatility and sideways markets are a stock picker's best friend.” -- The Motley Fool, www.Fool.com

Praise for Active Value Investing

"This book reads like a conversation with Vitaliy: deep, insightful, inquisitive, and civilized." -- Nassim Nicholas Taleb, author of The Black Swan

Q&A with Author Vitaliy N. Katsenelson

What approach do you recommend taking in sideways markets?
What I propose in the book (and practice in life) is active value investing. Instead of being a market timer, I’m a buy-and-sell investor, with a focus on valuing individual stocks.

Find stocks that lie within your circle of competence, analyze them as to whether they meet your qualitative criteria (such as competitive advantage, strong balance sheet, high return on capital, shareholder-friendly management. etc.), value them, determine an appropriate margin of safety (discount to fair value, which should be increased in range-bound markets), and you’ll thereby arrive at a price at which you’d want to buy them.

If a stock trades at or below your buy price, buy it; if not, put it on your watch list. When the stock reaches your fair-value level, you don’t hold it, you sell it. Repeat this process over and over again.

What is one piece of advice you’d give to readers about investing in sideways markets?
An investor makes money from stock appreciation and dividends. Stock appreciation is driven by P/E expansion and earnings/cash flows growth. If you see an apparent catalyst (news or event) that will force P/E to go up – great! But in my experience I found that it is the apparent absence of a catalyst that creates an undervaluation. Wall Street is fairly short-term oriented, therefore if the stock is undervalued but there is no reason or a catalyst to help it go up in the next quarter or two, it gets dumped.

Here is what I propose. Buy stocks that grow earnings and pay dividends, this will put time on your side -- you are getting paid to wait.

Earnings growth is compressing P/E under the stock and dividends are a real time payment for your patience. If a company doesn’t grow earnings and pays little dividend, make sure undervaluation (potential P/E expansion) is significant, or there is a clear catalyst, as time is not on your side in this case. For instance, if you find a stock that is 20 percent undervalued, there is no catalyst, no dividend or earnings growth it is probably not worth buying.

What is a “don’t” when it comes to investing in sideways markets?
We need to shield ourselves from the outside world. I am not advocating moving into a cave with no electricity. But we should not allow the outside into our lives unchecked. If we do, the market will become our master, dictating what we do – which is the opposite of what we should be doing. I actively try to isolate myself from influences of the market. I found the most productive time I have is on airplanes, because I can write and think for hours; there is little interference by the outside world. I really try hard to only check the prices of my stocks a few times a day. I have not perfected this yet — we all have bad habits that it takes time to break. But if we are aware of the negative influences the outside world can have on us, there may be hope for changing our behavior.

I usually try to read newspapers and otherwise keep up with the news before I get to the office. Then I try (this is still an effort) to turn off the Wi-Fi switch on my laptop — this kills the internet, including email, Skype, IM, and RSS feeds. I try to recreate a plane-like environment at work. I don’t turn on the TV during the day. And when I do tune back in, I try to listen to more podcasts, and watch PBS more and business TV less. So to answer your question, I think we should create an environment where the outside world doesn’t change (shrink) our time horizon.

Editorial Reviews

Review

“This is a book you can understand and have fun with no matter what level of experience you have.  Even advanced investors have to refresh themselves in the basics once in awhile. Read it . . “ (Financial Tides and Seeking Alpha)

“This book isn’t about market timing. It’s about winning in a flat market — the sort of knowledge that can make you a lot of money. In his book, Katsenelson reminds us that investing returns come in three ways: more earnings, more dividends, or a higher price-to-earnings ratio. I’m a dividend guy, so Katsenelson had me when he declared that ‘the importance of dividends quadruples in sideways markets, where they historically represent more than 90% of total return.’ Amen, brother! There are a lot of ‘little books’ out there, but The Little Book of Sideways Markets offers excellent advice, reads easily, and will help you sidestep a potentially frustrating market.”(Motley Fool)

“Offers guidance on the discipline of selecting stocks, as well as wisdom on the challenges of knowing when to sell.  Does a masterful job of taking a highly technical subject and explaining it in easily understood terms.  His explanation of discounted cash flow analysis to determine the right price for buying an asset is the best, and the most entertaining.” (NAPFA Advisor)

“Thoroughly enjoyable . . for the thoughtful and often entertaining way in which it is delivered. . . Katsenelson takes his reader step by step into the mind of the value investor by relating, in a fictional addendum to Fiddler on the Roof, the story of Tevye’s purchase of Golde, the cow. He also describes his own big-time gambling evening (he was willing to lose a maximum of $40) and that of a half-drunken, rowdy fellow blackjack player to stress the importance of process. He then moves on to the fundamental principles of active value investing.  What differentiates this book from so many others on value investing is that it describes, sometimes through the use of case studies, the thinking of a value investor. Not just his models or his metrics but his assessments. Katsenelson is an empiricist who weighs facts, looks for contraindications, and makes decisions. He makes value investing come alive.  This may be a little book, but it’s packed with insights for both novices and experienced investors. And it is a delight to read.” (Seeking Alpha)

 

From the Inside Flap

With the stock market turning into a roller-coaster ride of all-time highs and stomach-churning lows, where does that leave your portfolio? Pretty much back where you started in 2000. Which may be fine for visitors to Six Flags, but for your retirement, savings, and investments, you'd like to actually get somewhere.

In The Little Book of Sideways Markets, respected value investor and author Vitaliy Katsenelson shows you how to survive a stagnant market that's neither bull nor bear but instead what he calls a cowardly lion—it displays occasional bursts of bravado but is ultimately overcome by fear.

Katsenelson, known for the commonsense principles he has written frequently about in the Financial Times, Bloomberg Businessweek and elsewhere, decodes the theories and cuts to the chase with practical and timely strategies for how you can survive and thrive during a sideways market—a state of affairs, by the way, we should expect for the next decade. He'll show you:

• Why your investments will stall in neutral and what to do about it
• Why, despite its place as the Rodney Dangerfield of investing, you should treat mean reversion with respect
• Why Tevye was a rich man—and what you can learn from his purchase of Golde, the cow
• How the dire state of economic affairs in China and Japan will impact your investments, and what to do about it
• The three crucial concepts of value investing—Quality, Growth, and Valuation
• How focus on process, boring as it may sound, leads to success
• Why you should become a born-again value investor
• How to break bad habits and find, buy and sell stocks in a sideways market

Making progress in a sideways market is difficult, but the lively and entertaining Little Book of Sideways Markets will help you triumph even when the market is stalled.

See all Editorial Reviews

Product Details

• Hardcover: 226 pages
• Publisher: Wiley; 1 edition (December 7, 2010)
• Language: English
• ISBN-10: 0470932937
• ISBN-13: 978-0470932933
• Product Dimensions: 5.4 x 0.9 x 7.4 inches
• Shipping Weight: 9.9 ounces (View shipping rates and policies)
• Average Customer Review: 4.3 out of 5 stars  See all reviews (27 customer reviews)
• Amazon Best Sellers Rank: #363,610 in Books (See Top 100 in Books)

More About the Author

VITALIY N. KATSENELSON, CFA, is Chief Investment Officer at Investment Management Associates. Whilehis primary focus is on discovering under-valued companies for his clients, he is also known for his uncommon common sense, which he has regularly expressed in articles in the Financial Times, Barron's, Bloomberg Businessweek, the Christian Science Monitor, Institutional Investor, and the New York Post, among other outlets. He speaks frequently to investment groups around the world, and was most recently profiled in Barron's in September 2009. Previously, he was an adjunct faculty member at the University of Colorado Graduate School of Business, and he is also the author of Active Value Investing.

Most Helpful Customer Reviews

64 of 67 people found the following review helpful

3.0 out of 5 stars A Summary of Active Value Investing December 26, 2010

By Erik T. Nelson

Format:Hardcover|Amazon Verified Purchase

Vitaliy Katsenelson's new book can, in my mind, be broken up into three parts. He begins with his argument that we are in a sideways market. He follows that up with a bit of a tutorial on value investing, and finishes with a few miscellaneous observations.

His sideways market thesis is that following a secular bull market, such as we had in the 90s, we are doomed to spend a number of years in a sideways market. It wiggles around, but ends up roughly where it started. He does some calculating, not to predict the precise length of the sideways market, but to give the reader an idea of the factors involved. (If his assumptions are correct, the current sideways market has another 11, or maybe14 years to go. I don't have a lot of faith in the precise numbers he uses, but neither does he, so that's no criticism.) The central reason for making the sideways market argument isn't to pinpoint the length of the market move, but to convince the reader that, in such a market, it's tough to make money just by being in the broad market, or by being a buy-and-hold investor. We can however, make money by opportunistically buying individual stocks when they are cheap, and selling them when they are fully valued. Don't time the market, but do time individual stocks.

The middle of the book (chapters 4-12) is a tutorial on value investing. I don't think it contains anything that well-read investors won't have come across elsewhere, but it is put together nicely, and pays attention to a few ideas that are often ignored or underplayed in the value investing literature. Specifically, there is a nice piece on the importance of focusing on process, rather than outcome (an idea popularized, though by no means discovered, by Nassim Taleb) and a chapter on ways that poor management can destroy free cash flow. Value investors sometimes treat free cash flow as the holy grail of investing and valuation, ignoring the ways management has historically handled the cash, either creating or destroying value.

The book concludes with a group of largely unrelated chapters ranging from a mildly behavioral-finance influenced pep-talk to a critique of the Chinese economic model. A few of these are interesting, a few are a waste of paper and ink (chapter 13, I'm looking at you).

My biggest criticism of the book is that I'm not quite sure what the target audience is. The first few chapters are a bit on the technical / numerical side for a rank beginner, and don't contain enough data or a strong enough argument to really convince a more experienced investor who doesn't already agree with the thesis. Yes, the pattern of bull market followed by a range-bound market has occurred a few times over the last 100 years, but the ranges and lengths have varied a lot, and I saw no compelling reason to think that a bull market couldn't start from a higher level than Katsenelson thinks it could, that we couldn't have another bear market (such as the one post-1929), or any of a number of other possible scenarios. Investors often make the mistake of thinking that this time is different, but they also make the mistake of thinking that the future will be just like the past. In the end though, I don't think that the sideways market thesis is important, beyond the idea that we can make money when the overall market isn't moving strongly up or down. I've been following a method similar to the one he advocates here since the late 90s, and have experienced success with it personally, so I didn't need much convincing.

The value investing tutorial portion of the book appears to be written for the true beginner, using very simple and non-technical examples, but I don't believe it goes quite far enough to be the sole resource of a new investor. Where should an investor go to get the sort of information on a company that Katsenelson recommends using? How do you read a cash flow statement, or a balance sheet? How do you read a 10-q, or a 10-k, or a proxy statement? Should you be reading these at all? I think it's a rare investor who knows these things, but still needs Katsenelson's farmer-buying-cows example to figure out why free cash flow is important.

My primary question before buying the book (which I could not, at the time, answer) was what this book would offer to someone like myself, who had already read Katsenelson's previous book, Active Value Investing. The answer is "very little." I loved Active Value Investing. I wasn't entirely convinced by his range-bound-markets hypothesis, which has been re-named "sideways markets" in the current book, but thought that the meat of the book, on value investing techniques, was great. Most of the current book is an abbreviated version of Active Value Investing, with liberal use of the cut and paste function. Large chunks of the books are identical. Many chapter headings are the same. The last few chapters are new, but not particularly useful, and most of their content will be familiar to anyone who reads Katsenelson's blog. If this Little Book were his first effort, I would certainly recommend it to the intermediate investor. Too much knowledge is presumed for this to be useful to the novice, and an experienced investor is unlikely to find anything both new and useful. It is not his first book though, and it is, in almost every way, inferior to his first book, Active Value Investing. Read that instead.

62 of 66 people found the following review helpful

4.0 out of 5 stars Aleichem reincarnated as a value investor December 6, 2010

By Brenda Jubin

Format:Hardcover

Vitaliy N. Katsenelson's The Little Book of Sideways Markets: How to Make Money in Markets That Go Nowhere (Wiley, 2011) is thoroughly enjoyable, not so much for the message as for the thoughtful and often entertaining way in which it is delivered. It is part of the "Little Book Big Profits" series that began with Joel Greenblatt's The Little Book That Beats the Market in 2005 (recently updated) and now includes fifteen titles.

Katsenelson's hypothesis is that we will likely be in a sideways market, personified by the cowardly lion, "whose bursts of occasional bravery lead to stock appreciation but are ultimately overrun by fear that leads to a descent," until about 2020. (p. 3) His reasoning is that we are experiencing earnings growth but continuing P/E compression: the gains we get from earnings growth are wiped out by a decline in P/E ratios. Even though there can be a lot of cyclical volatility, over the long haul stock prices will stagnate. Until the 12-month trailing P/E falls "significantly below the historical average of 15" (by mid-2010 stocks were trading at more than 19 times 2010 earnings) the sideways market will continue. (p. 27)

If this hypothesis is borne out, buy and hold (never a great idea in any environment) absolutely must be replaced with buy and sell. "A disciplined sell process injects a healthy dose of Darwinism ... into the portfolio, weeding out the weakest stocks--the ones that have deteriorated fundamentals or diminished margin of safety--in favor of stronger ones." (p. 164) That is, once the reasons you bought the stock (valuation, quality, and growth) have disappeared, sell and move on.

Katsenelson takes his reader step by step into the mind of the value investor by relating, in a fictional addendum to Fiddler on the Roof, the story of Tevye's purchase of Golde, the cow. He also describes his own big-time gambling evening (he was willing to lose a maximum of $40) and that of a half-drunken, rowdy fellow blackjack player to stress the importance of process. He then moves on to the fundamental principles of active value investing

What differentiates this book from so many others on value investing is that it describes, sometimes through the use of case studies, the thinking of a value investor. Not just his models or his metrics but his assessments. Katsenelson is an empiricist who weighs facts, looks for contraindications, and makes decisions. He makes value investing come alive.

This may be a little book, but it's packed with insights for both novices and experienced investors. And it is a delight to read.

13 of 13 people found the following review helpful

4.0 out of 5 stars What Does a Farmer and Cow Have To Do With Speculation? December 26, 2010

By JEFF PIERCE

Format:Hardcover

I had the pleasure of listening to Vitaliy Katsenelson speak about his investing ideology at Agora Financial this summer in Vancouver, who when introduced was described as the "quintessential value based stock picker." Vitaliy took the stage and clarified himself as a "value investor who likes to communicate." I concur after reading his newest book, The Little Book of Sideways Markets: How to Make Money in Markets That Go Nowhere (Wiley, 2011). Vitaliy does a great job at telling simple stories that teach complicated lessons within the financial markets, while embedding value investing wisdom within those stories, so that we may capitalize when the markets are caught in a range, which he calculates to be 50% of the time.

From a trader's perspective "Sideways Markets" also provides real world advice for active traders that I can utilize within my trading plan tomorrow, while filling in any gaps that technicians may lack in the fundamental analysis department. As an active trader my biggest concern when reading an investing book is what can I take away from this book and use right now. Whether Vitaliy wants to admit he has a little active trader in him or not, it's quite apparent when you analyze the markets in hopes of gaining an edge from future direction, while adjusting your strategy along the way...that is described as trading. It's really just a question of time frame at this point.

My two favorite lessons for short-term traders in this book are brilliant in their simplicity. Vitaly tells a story about a farmer named Tevye and his cow Golde, that anybody can understand, illustrating the concepts of value investing, margin of safety, and the pitfalls of speculation. At the end of this fable was a very insightful concept that is more applicable to momentum investing than he probably realizes. "That's why I stopped bidding on sunny days when everybody's got a smile on their face." We all know about over exuberance and how it suckers most traders in at the exact wrong time.

The other lesson comes in the chapter Vitaliy recalls an experience he had at a casino. It's been well documented by many the similarities of professional gamblers to that of traders and the need to "spend more time focusing on the process, not on the outcome." Both need to protect their bankroll and they do that through a rigid system, and the personal discipline to follow that system no matter what their emotions are telling them. Traders and Gamblers both know when to follow through with the big bet while keeping their losses small to fight another day. If you allow your system to play out over the course of many trades and you have a profitable edge, you put the odds in your favor and you become the house, as long as your emotions are kept in check.

To better illustrate how accurately titled this book is, I've included a chart(see [...]for chart) The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere (Little Books. Big Profits)of the S&P since 1997 showing how there has been a whole lot of up and down action, but essentially we've ended up right where we started. While markets, sectors, and stocks will continue to go up and down, Vitaliy points out that "the easiest way to combat p/e erosion is to increase the required margin of safety for stocks in your portfolio." And to do that you must become a stock-picker and analyze each individual stock with the components of quality, evaluation, and growth as the basis of your purchases. Only then will you put the odds in your favor to combat the roller coaster that has become the stock market.

If I had to disagree with any one thing within the book it's when the author states to sell a stock. When a stock reaches fair value, Vitaliy preaches that the stock should be sold, instantly. This goes against my trend trading rules because as long as the stock is moving higher, it would be in a trader's best interest to enter trailing stop to give one the potential to capitalize on more upside potential should the stock continue higher. I agree with the author that one needs to have zero emotions around your stocks, but it also is in your trading performance's best interest to stay invested when stocks are moving higher, as long as your trailing stops are in place.

Vitaliy's lastest book is thoroughly enjoyable, easy to read, and covers many different topics that your sure to learn something new as you make your way though it. I can say that after seeing him in person and reading this book, Vitaliy has a great understanding in what it takes to outwit the sideways markets that we find ourselves in.