Active Value Investing: Making Money in Range-Bound Markets

by Vitaliy N. Katsenelson

A strategy to profit when markets are range bound–which is half of the time One of the most significant challenges facing today’s active investor is how to make money during the times when markets are going nowhere. Bookshelves are groaning under the weight of titles written on investment strategy in bull markets, but there is little guidance on how to invest in range bound markets. In this book, author and respected investment portfolio manager Vitaliy Katsenelson makes a convincing case for range-bound market conditions and offers readers a practical strategy for proactive investing that improves profits. This guide provides investors with the know-how to modify the traditional, fundamentally driven strategies that they have become so accustomed to using in bull markets, so that they can work in range bound markets. It offers new approaches to margin of safety and presents terrific insights into buy and sell disciplines, international investing, "Quality, Valuation, and Growth" framework, and much more. Vitaliy Katsenelson, CFA (Denver, CO) has been involved with the investment industry since 1994. He is a portfolio manager with Investment Management Associates where he co-manages institutional and personal assets utilizing fundamental analysis. Katsenelson is a member of the CFA Institute, has served on the board of CFA Society of Colorado, and is also on the board of Retirement Investment Institute. Vitaliy is an adjunct faculty member at the University of Colorado at Denver - Graduate School of Business. He is also a regular contributor to the Financial Times , The Motley Fool, and Minyanville.com.

Genres: Finance, Business, Economics, Money

304 pages, Hardcover

First published January 1, 2007

About the author

Vitaliy Katsenelson was born in Murmansk, Russia, and immigrated to the United States with his family in 1991. After joining Denver-based value investment firm IMA in 1997, Vitaliy became Chief Investment Officer in 2007, and CEO in 2012. Vitaliy has written two books on investing and is an award-winning writer. Known for his uncommon common sense, Forbes Magazine called him “The New Benjamin Graham.”

He’s written for publications including Financial Times, Barron’s, Institutional Investor and Foreign Policy. Vitaliy lives in Denver with his wife and three kids, where he loves to read, listen to classical music, play chess, and write about life, investing, and music. Soul in the Game is his third book, and first noninvesting book.

Reviews

[InvestingByTheBooks.com · Rating 5 out of 5]

Reading this book in 2007, it had an immense impact on my thinking. The gravitating pull from valuations in a range-bound market – one of the book’s core ideas – nicely interlinked with the identification of great franchises. Active Value Investing also hit home in a few other ways; it dealt with the “dirty” topic of general market valuations and it was written by someone (then) outside the normal investing guru entourage. It also introduced an attempt to put the selling decisions on par with buying, both equally deserving of an articulated strategy. On top of that, the book goes into considerable detail explaining the “QVG-process” (Quality Valuation Growth) of evaluating potential investments, distancing the book from other more theoretical tombs. Finally, it is written by someone who cares about his reader, carefully nurturing every word like he is afraid the reader might otherwise lose interest, put the book down and thus miss all the goodies presented in the next chapter. In short, it is a book which most certainly will be seen in bookshelves of investing die-hards 50 years from now.

Re-reading the book cover to cover again, the first impression has lasted. Part I is an impressive tour- de-force into why we are in the age of a range- bound market, broadly estimated to last between the years 2000-2020. Written in 2007 with the markets at around ATH it took considerable cojones to make his argument as forcefully as the author does (as can be said today again). The importance of the range-bound market concept is needed to set the stage for the practical application of bottoms-up value investing techniques. Katsenelson is clearly concerned the pure value investor might cringe seeing this focus on the broader market. But he shouldn’t be. A core commandment of the valuation minded investor is arguably the belief around the equity markets being a market of stocks rather than a lump-sum stock market. Hence, this part is crucial to all active investors except the buy-and-forget-to-sell crowd that tend to grow in times of pro-longed bull markets. It is hard not to nod in approval while the author builds up the reader’s knowledge and appreciation for market cycles. And range-bound markets occur more frequently than you might think; about half the time in the last 200 years. They are characterized by falling PEs but rising profits, resulting in flattish total returns for investors (average is 0,6% real p.a.). They can be seen as a sort of “payback markets” as investors need to pay back in declining PEs for the excess returns of the preceding bull-market. An important caveat is exactly that; the author separates what he terms cyclical markets within the longer pull-and- tug between secular markets, whose average tenure is 17 years. The question is if it will remain so, with the rules of central banking being re-written as we speak, ushering in a new cast of intervention-prone actors in the monetary play, funnily enough correlating with more boom-bust cycles than ever before.

But, equity market cycles have been brilliantly illuminated before. It is in Part II – the practical applications section – being introduced to the QVG framework, that my scribbles, notes and references occupy almost every page. It is truly shared knowledge and very transparent – a practical guide more than anything. First and foremost, QVG treats investing as stock picking one company at a time, rather than pushing stocks into themes or styles, like sheep into their designated hemming. Fastenal was not a great investment because it ex-post fits into 2-3 quality criteria; it was a great investment because of corporate execution, a thriving market and a juicy starting valuation. Mr Katsenelson’s tools help separate the two. The sheer work of gathering numbers, painting a 20/20 vision and doing so in a language far from the typical dry finance-lingo deserves no less than top accolades. Add to that a suggested framework to incorporate into company research, and the only question remains: Do we have to wait until the year 2020 for Active Value Investing, 2nd edition?

[Douglass Gaking · Rating 5 out of 5]

I read a lot of books about finance and investing, and this is one of the best. I seriously put this on par with Benjamin Graham (The Intelligent Investor and Security Analysis, Warren Buffett (Berkshire Hathaway shareholder letters), and John Mihaljevic (The Manual of Ideas). It is that good.

Katsenelson's model for active value investing is designed for range-bound markets but works very effectively in all markets. He focuses on evaluating stocks for quality, valuation, and growth (QVG), then making buy and sell decisions based primarily on a P/E model.

This is not a simple buy stocks with low P/E and sell stocks with high P/E model. Katsenelson determines a stock's fair value P/E based on growth and risk factors. Instead of setting price targets for buying and selling, which will likely expire in a short time, the buy and sell targets are P/E levels. These work great no matter what is happening in the market. For example, right now there is a lot of uncertainty and volatility in the market, and inflation is on the rise. This has caused me to question my price targets and have trouble determining what the fair value of a stock is. Using a P/E system would work a lot better right now.

The only weakness I see in this system is in how P/E is calculated. The standard P/E might include non-recurring items that could throw off the formula. Even a tax policy change could throw a P/E ratio in a weird direction. The book does not do much to address this, but that is really the only criticism I have.

After experimenting with different types of value investing over the last 5 years, I started focusing last year on an active value investing strategy that uses a combination of valuation and technical analysis to trigger buys and sells. While reading this, I started plugging some of the book's formulas into spreadsheets and applying them to my strategy. I plan to keep using this book as a reference and getting better at incorporating Katsenelson's P/E model into my buy/sell strategy.

I highly recommend this book to anyone who is interested in long-term stock investing, especially if they want to enhance returns with a more active approach than buy-and-hold. In addition to having a great model, it is well written and has good advice about investing in general.

[Ted · Rating 4 out of 5]

A very good take on the basics of value investing. I particularly like the models and formulas that Katsenelson spells out. The Tevye analogy is a GREAT tool for a primer on valuation and source of returns.

I would LOVE an updated version of this book and it would probably earn an extra star. Written in 2007, the book portends a range-bound market when, in fact, both opposites occurred: the "Great Financial Crisis" followed by a 10-year bull market. I don't fault the author for not catching those, but this fact does strain the relevance of the premise of the book. We find ourselves in 2019 with slowing global economic expansion and world-wide interest rates on the low end of the spectrum, so a range-bound market is well within the realm of possibility. Second edition, please!

[Jim · Rating 3 out of 5]

Ok if you have the time and expertise

I think this book does a great job of making the case for the author's approach for reliable returns, with honesty about how it compares to other approaches under different market conditions. However, following the advice requires great expertise and a great deal of time so I feel it is appropriate for only professional investors such as the author.

[Daniel Bratell · Rating 2 out of 5]

There is one thing that makes this ten year old book more interesting now than before, that it's talking about how to act when markets are not just going up. Some of the book's predictions was all wrong, and some were correct, which also acts as a reminder that nobody really know what will happen. Least of all those that seem the most confident.

(There is a reason it is called confidence man, con man)

[Carlos Villegas · Rating 5 out of 5]

De mis mejores maestros Katsenelson

[Anders Gränfors · Rating 5 out of 5]

A must for all investors

[Sheep Invest · Rating 5 out of 5]

As a fairly new investor, this is the book that has influenced my investing style the most. Katsenelson introduces the Absolute P/E model, which is an easy-to-understand way to value companies. The purpose of the model is to figure out what the fair P/E multiple is for a certain company based on criterias such as quality and growth. From the fair P/E multiple you can then work out at which P/E multiple you should buy and sell the stock. Just like for any other valuation model the usefulness of it is dependant on the quality of the inputs, so you still have to do all the work in learning about the quality of the company and its future growth prospects, and so on.

For me this was a very useful tool to have during the recent corona crash. As everything fell, even companies whose businesses were not negatively impacted by the virus, I think having some hard numbers to look at helped me stay somewhat rational. I could open Excel and see which companies, that I had already done the work on, offered the best risk/return.

If you're an experienced investor with a succesful strategy that has served you well over many years this book could perhaps come across as too basic, but for the new and intermediate investors I absolutely recommend it.

[Brian Zheng · Rating 4 out of 5]

This is a good "How to do it" book following up on the Secular Stock Market Cycles thesis, the idea brought up in that I reviewed before. Since we are currently in a ranged bounded market that is categorized as long run rising EPS but contracting PE ratio, the author argued that utilizing a disciplined buy and sell mechanism could take the best advantage of this market while buy and hold will lead to minimal return (after more than a decade and rising EPS, S&P 500 is still 7% below its 2010 level). The core of the book is the Quality, Valuation and Growth framework and the author presented a guidance formula to decide the PE ratio to buy or sell a stock taking consideration of quality, growth prospect of the business and margin of safety to valuation. The formula may be too simple without considering all the factors but it's a good start to work out your own buy/sell level.

[JK · Rating 3 out of 5]

Basic, common illustration with foundation in value investing explained. Easy for beginner to read. For intermediate investor, it might worth some time to recapture some basic foundation and valuation view point.

The concept is to find a company with quality, growth, and valuation, just like other value investing books. However, Katsenelson not only recommended buy undervalued stocks, but also sell it when the stock is overvalued. The idea behind this is that stock price always fluctuated within a range, created opportunity to buy low and sell high for higher profit rather than buy-and-hold strategy.

The valuation method discuss in book is based on PE ratio which estimated based on profit growth and dividend yield. Easy concept to understand, and all the art for valuation is determine future growth rate and dividend yield.

[Colin · Rating 4 out of 5]

While I agree with Ben on many of his points, I really do think this time period is analagous to the time period of 1967-1982, when the Dow stayed at 1000 points for almost 15 years. Granted if the future resembled the past, we'd be able to predict it.

I like this book because it seems there are so many books, articles and pundits who are overly optimistic, when in fact, there are many things to worry about. I admire Mr. Katsnelson's views, because he is holding contrarian opinions, which is very hard to do in his industry.

I think Mr. Katsenelson uses some great case studies and wished he had done more.

[Tyson Strauser · Rating 4 out of 5]

katsenelson correctly argues that we are in a long period of declining price multiples in markets. Since the end of the previous bull market in 2001, we have been in a secular bear market. While Katsenelson thought this might express as a sideways, range-bound market, the result is the same. We have seen market multiples collapse and Katsenelson's insightful views have been useful in navigating the bear market of 2008.

[Alexis]

still reading, makes sense so far

[Sid1983 · Rating 2 out of 5]

not much in there
bottom line, investing in cos with high RoICs, understand why the RoIC is high and is that sustainable
otherwise uses the same model i use of QVCG
nothing new

[Jennie Tao · Rating 2 out of 5]

Read it over the weekend. I expected a lot from the book but found it too basic and common sense. Others might find it useful though...think twice.

[Joshua Norman · Rating 5 out of 5]

One of the few required books for college classes that I enjoyed reading.

[Bill · Rating 2 out of 5]

would suggest only reading the back.