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CFA Institute Active Value Investing: Making Money in Range-Bound Markets. 2007 by Vitaliy N. Katsenelson Review by: Martin S. Fridson Financial Analysts Journal, Vol. 64, No. 3 (May - Jun., 2008), pp. 101-102 Published by: CFA Institute Stable URL: http://www.jstor.org/stable/40390222 . Accessed: 12/06/2014 12:52 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. . CFA Institute is collaborating with JSTOR to digitize, preserve and extend access to Financial Analysts Journal. http://www.jstor.org This content downloaded from 195.34.78.30 on Thu, 12 Jun 2014 12:52:44 PM All use subject to JSTOR Terms and Conditions

Active Value Investing: Making Money in Range-Bound Markets. 2007by Vitaliy N. Katsenelson

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CFA Institute

Active Value Investing: Making Money in Range-Bound Markets. 2007 by Vitaliy N.KatsenelsonReview by: Martin S. FridsonFinancial Analysts Journal, Vol. 64, No. 3 (May - Jun., 2008), pp. 101-102Published by: CFA InstituteStable URL: http://www.jstor.org/stable/40390222 .

Accessed: 12/06/2014 12:52

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp

.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact [email protected].

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CFA Institute is collaborating with JSTOR to digitize, preserve and extend access to Financial AnalystsJournal.

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Book Reviews

In lieu of the more traditional P/E, Napier bases his valuation on Tobin's q, the ratio of a company's market capitalization to the replacement cost of its assets. Napier's key insight is that extreme market undervaluation arises only partially from price declines during crashes. Much of the cheapness results from the failure of stock prices to advance in line with growth in economic activity and earnings.

Napier's research has uncovered another piece of information that flies in the face of the conventional wisdom that bear markets are surrounded by bad news. Napier's examination of Wall Street Journal arti- cles indicates otherwise. During all four periods examined, ample good news was reported. Many investors, however, have a hard time seeing the good news after a protracted bear market. Given human nature, this inefficiency is unlikely to change.

Anatomy of the Bear is not only a study of bear markets; it is also a fascinating glimpse into the history surrounding those episodes. The Wall Street Journal extracts that Napier selects, although subject to the

author's biases, provide insight into world events that help explain the behavior of stocks. The events include the attack on Pearl Harbor, the Cuban Missile Crisis, presidential elections, and the Vietnam War.

Only time will tell whether August 1982 turns out to follow the pattern of the previous three great mar- ket bottoms. Still, it is worthwhile to recall the widely quoted remark of philosopher and essayist George Santayana, "Those who cannot remember the past are condemned to repeat it," and to add our own invest- ment version: Those who cannot remember the past are unlikely to prosper from it.

Napier has done an excellent job of weaving together historical events with investor sentiment sur- rounding the four great market bottoms, comple- mented by his own analysis and commentary. The book is an interesting read, not only for fans of financial history but also for those with the practical objective of identifying exploitable patterns in market cycles.

- R.L.M.

Notes 1. In this context, an event study is designed to determine

whether past occurrences of a given type of event, which is hypothesized to affect public companies7 market values, produced statistically significant price reactions.

Katsenelson, a portfolio manager with Invest- ment Management Associates and an adjunct faculty member at the University of Colorado Denver Busi- ness School, contends that the U.S. market will remain range bound until approximately 2020. He does not project a sluggish economy for the next dozen years but, rather, shows that the link between economic perfor- mance and stock performance is looser than generally supposed. Katsenelson concludes in the first part of his book that to achieve the 7 percent real returns that they have been led to believe are their birthright, investors will have to own the "right" stocks.

The second part of the book purports to teach investors how to find the desired stocks. These chap- ters are of limited interest to CFA charterholders. They constitute a primer on securities analysis based on the dubious proposition that individual investors have a realistic chance through stock picking of improving upon the market's expected lackluster returns.

Hewing to the conventions of the how-to genre, Katsenelson offers a systematic-seeming approach to stock picking, but it is not much different from those found in countless other such works. The text is sprin- kled with bromides ("Know your limitations") and an avalanche of quotations of Warren Buffett. Nowhere do readers find an investment record to suggest that applying the book's recommended methods might actually enable them to achieve superior results.

Active Value Investing: Making Money in Range- Bound Markets. 2007. By Vitaliy N. Katsenelson. John Wiley & Sons, Inc., (800) 225-5945, www.wiley.com. 282 pages, $49.95.

Reviewed by Martin S. Fridson, CFA.

Financial services firms energetically encourage the belief that the U.S. stock market has cranked out, decade after decade, a steady 7 percent real return. By investing for the long term, individuals supposedly can count on building their nest eggs at this highly predictable rate. The reality is quite different, as Vitaliy N. Katsenelson details in Active Value Investing: Making Money in Range-Bound Markets.

Upon close examination, the span 1937-2000 con- sisted of four distinct phases - two extended bull mar- kets (1937-1950 and 1966-1982) and two lengthy periods (1950-1966 and 1982-2000) in which stocks remained within a narrow range of valuations. Patient investors fared quite differently depending on whether prices were steaming higher or stuck in the mud. Annual real returns averaged 13.8 percent during the bull markets but only 0.6 percent during the range- bound periods. An investor who bought a broadly diversified stock portfolio at the beginning of 1966 had to wait 34 years to achieve a 6.8 percent real return.

Martin S. Fridson, CFA, is CEO of FridsonVision LLC, New York City.

May/June 2008 www.cfapubs.org 101

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Financial Analysts Journal

Also true to the form of popular books on invest- ment, Katsenelson repeats a few common errors. He incorrectly attributes to baseball immortal Yogi Berra a remark of the late computer scientist/educator Jan L. A. van de Snepscheut: "In theory, there is no differ- ence between theory and practice. But, in practice, there is." For good measure, he repeats the mistake a few chapters later. Katsenelson also perpetuates a misunderstanding of the famous 17th century tulip bulb speculation by stating that the flowers them- selves were regarded as valuable assets.1

Notwithstanding such flaws, Active Value Invest- ing makes several points worthy of notice by profes- sional analysts and money managers. Highlighting

the hazards of relying on one widely used valuation tool, the author documents a range of estimated betas for Wal-Mart Stores of 0.17 to 0.90- all published in the same month by three reputable financial informa- tion providers. Katsenelson also helpfully reminds readers of the contrary-to-popular-wisdom finding of Rob Arnott and Cliff Asness that high-dividend- paying companies display high earnings growth.2 Nuggets of this sort make Katsenelson's well- organized, clearly written book worth a look, even for market veterans in no need of basic lessons on cash flow and diversification.

- M.S.R

Notes 1 . See the review of Peter M. Garber's Famous First Bubbles: The

Fundamentals of Early Manias in Financial Analysts Journal (March/ April 2001):84-85.

2. Robert D. Arnott and Clifford S. Asness, "Surprise! Higher Dividends = Higher Earnings Growth/' Financial Analysts Journal (January/February 2003):70-87.

The Standard & Poor's Guide to Selecting Stocks. 2005. By Michael Kaye. McGraw-Hill, (877) 833-5524, www.books.mcgraw-hill.com. 244 pages, $24.95.

Reviewed by Murad J. Antia, CFA.

A relatively short time ago, running quantitative screens and models for equity selection was a labori- ous and time-consuming process. Computer code had to be written for mainframe computers, and databases such as Compustat, I/B/E/S, and Zacks Investment Research were procured, at substantial, expense, on computer tapes.

How times have changed! In The Standard & Poor's Guide to Selecting Stocks, Michael Kaye, a port- folio analyst for Standard & Poor's (S&P) Investment Advisory Services, lists numerous websites that pro- vide screening capabilities for stocks, bonds, and mutual funds. Within a matter of minutes, investors can create a set of screens that satisfies their security selection criteria. And in most cases, it is costless.

According to Kaye, screening helps reduce a large universe of possibilities into a smaller set and removes the emotional element from security selection. More- over, he claims that it levels the playing field between individual and institutional investors. If individuals take the time to educate themselves, they can develop their own investment ideas as opposed to following the herd, which is a surefire means of getting average or below-average performance.

Murad J. Antia, CFA, teaches investments and financial statement analysis at the University of South Florida, Tampa.

Individual chapters are devoted to presenting screening criteria for growth, value, growth at a rea- sonable price (GARP), momentum, and dividend- paying stocks, to the selection criteria for stocks in specific sectors, and to the criteria for identifying stocks with negative characteristics, such as illiquid stocks and stocks of companies with high debt levels and low amounts of cash on the balance sheet.

In addition to the primary screens for a particular style or sector, the author recommends screens that he considers relevant for superior stock selection. For example, when screening for GARP stocks, the pri- mary screen is the P/E-to-growth (PEG) ratio. The secondary screens eliminate stocks with debt-to- equity ratios that are above the industry average, stocks with return on equity (ROE) that is below the industry average, and stocks covered by fewer than five analysts. His rationale for the secondary screens is that a high ROE combined with a low debt level shows that the company is profitable but that the growth has not been achieved by assuming risky leverage. In addition, requiring coverage by at least five analysts prevents the average growth estimate from being skewed by an outlier estimate.

Kaye also mentions qualitative factors that need to be incorporated in the analytical process for each of these selection criteria, although the qualitative sec- tion of the analytical process is cursory at best. The book is peppered with insights that are to be taken at face value. For instance, he states that the best overall ratio for evaluating pharmaceutical stocks is the PEG ratio. Although he provides reasons supporting PEG, he does not present empirical evidence that would substantiate his reasoning.

102 www.cfapubs.org ©2008, CFA Institute

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