The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere

by Vitaliy N. Katsenelson

"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 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.

Genres: Finance, Business, Nonfiction, Economics

256 pages, Hardcover

First published November 17, 2010

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

[Đạt Tiêu · Rating 3 out of 5]

Basically, in sideway markets, buy-and-hold may turn out to be buy-and-sell. Some notes

A. Stock market basic
1. Types of stock markets
- Bull market: price up
- Bear market: price down
- Sideway market: price stays in a small range
- Cyclical market: from months to a few years
- Secular market: above 5 years
-> In most cases, sideway markets follow bull markets, each lasts about over 10 years
In between, some cyclical bear markets happen

2. Stock return
- Short-term driven by market sentiment, crowd emotion and investor expectation
- Long-term driven by earning growth(fundamentals in general) and changes in (relative) valuation (P/E changes)
- Total stock return = dividend yield + capital gain yield
capital gain yield <- earning changes + P/E changes

B. Sideway market characteristic
- Secular sideway = cyclical bull + cyclical bear (in big pictures)
- Bear: earning down + P/E down
- Bull: earning up + P/E up
- Sideway: earning up or remain + P/E down (P/E compression because of low expectation)
- P/E tends to reverse to the mean
-> Careful with 'Earnings' because of volatility and noises -> should norminalization over a long period (5, 10 years)
-> Take into account real earning growth with the affect of inflation/deflation
-> compress P/E ratio -> decrease/increase real return
-> Also consider dividend yield = dividend per share / price <- dividend payout ratio + earning multiple (E/P)
- In sideway market: some stocks likely underperform fixed-income instruments

C. Some valuation tools:
- Relative valuation: price multiples (used in peer comparison)
- Absolute valuation: such as DCF -> take into account risk and return (by the discount rate)
- Randomness from market might fool you!

D. QVG framework: Quality, Valuation and Growth
1. Quality:
-> Sustainable economic advantages (survive competition)
-> High ROC (need less equity/debt to finance)
-> Good management board
-> Strong balance sheet (less debt less risk)
-> Significant free cash flow
-> Predictable earning

2. Growth
-> Growth: revenue, net income (earning), free cash flow, dividend
- Revenue Growth. Check if business:
-> sell more products/service
-> enter new markets
-> raise prices
-> lower prices (compensate in bigger quantity)
-> M&A
- Income(Earnings) growth. Check if business have:
-> operating efficiency (cutting cost)
-> economies of scale (<- high sales + high ratio of fixed cost to variable cost)
- Free cash flow. Check if business perform:
-> stock buyback -> EPS up
-> Buy back at good (undervalued) price?
-> what motivation to buy back?
-> Use debt to buy back?
-> is there a better way to use free cash flow beside buying back stocks?
- Dividend:
-> In extreme cases, high dividend payout ratio means less growth rate (not much cash left to re-invest for growth)
-> The past dividend payout ratio may not repeat

3. Valuation
- Relative valuation: price multiples
-> P/E: do peer comparison, compare P/E over a period, compare with benchmarks -> why it is like that
-> Past valuation may not continue
- Absolute valuation:
-> DCF: bring back all future cash flow to net present value then discount it with a discount rate
which presents the required rate of return (also the rate of risk, equally: high risk <-> high return)
-> DCF depends on multiple factors -> not a exact number, but a range of values
-> DCF helps understand affect from value creators and value destroyers of the business
-> Large margin of safety: buffer for errors from value estimation,
less sensitive to bad news (because of already low price to intrinsic value)
-> calculate DCF with many scenarios: bad, good, average
-> in sideway market: -> large margin of safety

E. Action
- Must have at least 2 in 3 (quality, growth and valuation)
- Buy stocks when they are undervalued, and sell them when they about become fully valued
- Good company: good quality and good growth
- Good stock: good valuation (undervalued)
-> Choose good company with good stocks
-> Track stocks by QGV not by market price
-> Sell when
-> Fundamentals become worse -> violate quality or growth
-> Stock price increases -> violate valuation criteria
-> Be careful with buy/sell emotion -> make decisions less reasonable
-> Take into account global economy affect like 'inflation export/import'
- Screening by:
-> low P/E and high ROE
-> low price-2-anything (extension from price multiples), low price-2-normalized-anything (over a long period)
-> low in weeks, months or years
-> classic Ben Graham: lower than net current asset
-> analyst recommendation
- Read more about asset allocation and portfolio management

[Jacob · Rating 4 out of 5]

This is quite an interesting book with a lot of ideas worth thinking about, if you have investments which you would like to see grow in the next several years. The author's basic idea is that, over periods of 5+ years, there are not bear markets as much as there are sideways markets where the market does not increase overall. This means buying and holding onto a market index fund does not get you anywhere during that time, and the question the author answers is, "What should you do instead?" Unfortunately, his answer involves doing a lot of your own work, which isn't feasible for those who don't invest professionally or at least as a hobby. For those who don't want to think about it too much, he answers indirectly "invest in a fund which focuses on dividends from a wide range of stocks".

Those who do want to think about how to invest and favor the value approach will find Katsenelson's ideas up their alley. Its core activity involve valuing a company and deciding at what heavily discounted level you would be willing to buy it. Once you've developed a large stable of companies you've valued, you should find ones that are attractive. Buy them until they're priced fairly (no longer discounted) and then sell them, and buy ones that have become discounted in the meantime. This approach takes advantage of market volatility during an overall stagnant market, but in a value-focused way that seems like it could work. I suspect it wouldn't succumb to the "if it works, everyone will start doing it and then it won't work" problem simply because it does take a significant amount of work to do, in addition to an even temper.

[Milan · Rating 3 out of 5]

Vitaliy Katsenelson's The Little Book of Sideways Markets offers a slight different take on value investing. It advocates a 'buy and sell' approach rather than the 'buy and hold' approach which is more common. Though he explains all the concepts very well, this book is not meant for beginners. You should have atleast some experience in investing to fully appreciate what the author is saying. The book is easy to follow and I'm sure I'll be able to add a few insights that I got from Katsenelson in my investing process.

[InvestingByTheBooks.com · Rating 5 out of 5]

In his second book, The Little Book of Sideways Markets one of the most successful young and upcoming value investors - Vitaliy Katsenelson - joins the many prominent writers in the “Little Book” format. The Russian born, US immigrant Katsenelson is the CIO of Investment Management Associates in Denver and he has previously written on their investment process in the 2007 publication Active Value Investing. The Little Book is in many ways a condense, better and clearer version of the previous book.

There are two main themes and they also make up the composition of the book. The first is to point out that just as the stock market historically has gone through long periods of 15 to 20 years where there were immense gains to be had, it has also gone through equally long periods where nothing much happened. The author also makes the point that we are now in one of these sideways markets since the year of 2000. The second theme is really about how you should act in one of these sideways markets and Katsenelson presents the value based “buy-and- sell” strategy they use at IMA.
Looking at multi decade trends Katsenelson draws the, perhaps obvious, conclusions that 1) the economies, and hence the corporate profits, have secular trends of growth or decline and 2) the price investors for these profits have secular trends of increases or decreases. Secular trends of declining economies and profits have really only occurred once, in the 1930’s, and so it is often the trends in what investors are willing to pay that define the stock market environment. In an environment where profits grow and multiples increase, markets rise and the main risk is not being fully invested in stocks in general. However, if the profits grow and the multiples decrease they cancel each other out and the market trends sideways. The opportunity cost of being invested in cash is much lower and only the right equity strategy will give a meaningful return.

To the investors the sideways market is by no means a calm horizontal journey because this journey is hidden behind the rollercoaster rides of the shorter investment cycle. These wild swings are what Katsenelson’s process tries to use to its advantage. IMA focuses on stocks that combine a) high quality in terms of good cash flows, high returns of capital, moderate debt and good management, b) growth of both profits and dividends and c) a margin of safety, i.e. a price discount to the intrinsic value of the stock. The point is that the volatility of the market sooner or later will eat away the margin of safety as the stock price goes up and then you sell. You then use the money to buy other undervalued stocks of good quality and with decent growth. If there are none, you simply park the money in cash until the opportunities arise again. Use the margin of safety as your market timer and cash for risk management.

All the “little books” are short, easily accessible, written in simple language and yet presents important topics told by authors with hands-on experience. This book is no exception, in fact it’s probably my favourite second only to Joel Greenblat’s Little Book that Beats the Market. Apart from the big topics, the book is full of useful hands-on advice - for example how to design your process and surroundings to minimize the hazardous noise of the stock market, how to structure the selling process etc.

Given its accessible form you might be fooled to think that this is a beginners’ book. However, if all seasoned veteran investors learnt the lessons Katsenelson presents, the investment arena would be an even more intensely competitive place. Read it and get an advantage.

[Löplip · Rating 5 out of 5]

Kort och koncis bok med heltäckande resonemang om hur börsen fungerar. Gillar upplägget med korta, lättlästa men slagkraftiga kapitel. Inga kapitel känns överflödiga likt många andra böcker kan kännas, utan allt känns relevant. Tycker att författaren gör ett fantastiskt jobb med att belysa hur viktigt det fria kassaflödet (tjänar bolaget pengar?) är att ta hänsyn till.

Mitt favoritkapitel var "Teyve Was a Rich Man", där Teyve ska köpa en ko på auktion och vill veta hur mycket han vill betala för den. Genom att räkna ut de framtida kassaflöden som kon kommer att generera (mjölkproducering + slakt - underhållskostnader) och diskontera dessa till ett nuvärde, samt att lägga på en Margin of Safety för oförutsägbara risker och svarta svanar, så får hon fram ett maxvärde av vad hon vill betala. De två första dagarna på auktionen skiner solen och det flockas av bönder som vill köpa kor. Priserna på kossorna överstiger Teyves maxpris med råge och det är inte förens den 3:e dagen, när det spöregnar och tomt på folk, som Teyve lyckas hitta en bra ko till bra pris.

Man kunde dra många paralleller till marknaden, och lika många lärdomar. Vänta på rätt tillfälle. Förhasta dig inte. Betala inte mer bara för att marknaden betalar mer. Ju mer du betalar ju högre är blir risken.

Boken belyser också vikten av värderingar, och hur tillväxtbolag som slutar ha tillväxt snabbt slaktas av marknaden rent värderingsmässigt. Likaså gäller det att dra öronen åt sig när börsen överlag värderas högt och att ändå vara medveten om de stora penseldragen inom makroekonomin. History doesn’t repeat itself, but it often rhymes.

[陈 元伟 · Rating 4 out of 5]

Written in 2011. For the value investors. What I really like is the description of the sideways market and how looking at PE expansion and compression, coupled with inflationary or deflationary environment, can help one to decide, using the framework of Quality, Growth and Valuation. Also, he suggested that value investors not only take a bottom-up approach, but also keep an eye on the macro level. A little basic for the experienced value investor but still a very nice read. Other interesting things mentioned are the prices of commodities such as oil and natural gas which eventually crashed a few years later. In addition, one of the last few chapters of the book also elaborated on the eventual unravelling of Japan and China debt. Very relevant and informative until today.

[Ram B · Rating 4 out of 5]

แม้บางเนื้อหาเป็นเรื่องที่นักลงทุนทั่วไปรู้กันอยู่แล้ว แต่หนังสือเล่มนี้ก็ช่วยให้เราได้กลับมาทบทวนวิธีคิดในการลงทุนอีกรอบในรูปแบบที่เข้าใจง่ายและยังมีกลยุทธ์ในการลงทุนสำหรับตลาด Sideways อีกด้วย ซึ่งถ้าเป็นนักลงทุนมือใหม่หรือคนที่สนใจจะลงทุนควรอ่านเล่มนี้เลย สิ่งหนึ่งที่ได้คือ mindset กับเครื่องมือการประเมินมูลค่าหุ้นที่ใช้การได้ง่าย สามารถไปประยุกต์ต่อได้

[Manikya Ramesh · Rating 5 out of 5]

This little book is good. I liked the way Mr Vitality has explained the concept of valuation using the milkman- Tevy as an example. His QVG ( quality, valuation, growth) approach for analysing value stocks is also very practical.

[Kevin · Rating 5 out of 5]

Well written, interesting mix of both historical context and investing strategy. Applicable to any market from a value investing standpoint, thoroughly enjoyed.

[Mehul Sutariya · Rating 5 out of 5]

This book gives good overview of whole market valuation.
Best book I found in little book series.

[Adam · Rating 4 out of 5]

This series of books about investing and finance is great. This one takes the angle of how to operate in a market that is not growing but rather maintaining.

[Tim Traver · Rating 4 out of 5]

Solid conceptual primer on active value investing.

[Birgir · Rating 2 out of 5]

Overly dogmatic. Not that impressed.

[James Boyce · Rating 4 out of 5]

Helpful and practical information about investing in stocks during times where the market is up and down and all around

[Tim Oltman · Rating 2 out of 5]

Not very prescient.

[Emma Pontzer · Rating 5 out of 5]

It talks about the pros and cons of a lot of things. Facinating.

[Arun Narayanaswamy · Rating 3 out of 5]

A good book on value investing more than what the title says. Good as it still covers well the aspects of picking, analysing and selling - including the psychological aspects of it.

[Jim Bouman · Rating 3 out of 5]

Rating: Optional

Bull markets are often followed not by bear markets, but by sideways markets in which P/E ratios revert to the mean and most stock returns come from dividends. Buy-and-hold works well in bull markets; an active buy-and-sell approach works better in sideways markets. Focus on companies with the right Quality, Growth and Value characteristics.

Extensive summary: https://jimbouman.com/the-little-book...

[Firsh · Rating 4 out of 5]

I totally forgot to review this so here it is. Isn't this supposed to be a shorter version of the active value investing book? I've just removed it from my to-read list. I mean Katsenelson is legit and I enjoyed his Tesla book. Not to sound arrogant, but the more investing books I read, the less new value I extract from them. I'm still trying to collect my memories on what this book was about and why I pushed 4 stars on it. Out of courtesy? Well it was at least little. And not a book, but an audiobook. meaning it was over quickly :D I mean the book is fine, but nearly all of them stop before uncovering EVA. I could scream but only do so in my head, YOU ARE SO CLOSE. But nah, they keep using traditional metrics, even if they are on the right track. Oh well. I have a very good investing newsletter with a system that resonates with me so I guess I'll be okay. These little books are affordable time investments, but I'm not sure how much more to gather on my list as they add less and less. Sorry for not remembering too many precise details of this very book...

[bookreader]

Most investors perform better in trending rather than range-bound markets; how then, do portfolio managers prosper in the context of global equity markets that have stagnated since 2000? Starting with the compelling premise that the US equity market will continue to trade sideways until 2020, Katsenelson argues that range-bound markets require radically different investment strategies. He then helpfully devises an "active value investing" framework for trading these flat-lining markets. Rejecting the buy-and-hold dogma that has held sway for a generation, he proposes to combine rigorous stock selection (based on quality, growth, and valuation) with a disciplined buy-and-sell program. With a gift for the wry, telling metaphor, as well as dozens of practical suggestions for equity analysis, the author distills the essence of his equally excellent first book into a handy pocket-sized guide to investing throughout the cyclical bull and bear markets that we'll likely face for the next decade.

[Russ · Rating 3 out of 5]

I've read a few of the books in this series. The useful ones succinctly present an investing philosophy with practical applications requiring the reader to perform further research into the efficacy of the philosophy. The worthless ones don't provide anything useful or are obsolete at printing. The Little Book of Sideways Markets is one of the useful books in the series. The author provides his take on value investing in the current market environment. The bi-polar nature of the stock market - careening from euphoria to depression - makes it difficult for traditional value investors to protect their capital. Katsenelson's premise makes preservation of capital an important part of his philosophy. I recommend this book with the caveat that the reader explore more material on value investing before implementing Katsenelson's philosophy.

[Nate · Rating 3 out of 5]

Definitely a book that needs to be read rather than listened to. There are too many parts that I would need to reread to ensure I understood while also looking at charts and graphs that makes the audiobook infeasible for good contextual understanding. I think the overall premise is useful and worth the time to better understand the concepts and to shore up my learning about financial markets and how they operate under various conditions.

[Anders Gränfors · Rating 4 out of 5]

Kort och intensiv. Inga formler, kurvor eller komplicerade resonemang.

Istället en sammanhängande historia bra om man läser Greenblatt Little Book that stil beats the Market. Innan man läser den här så får man än mer utväxling

[Jonathan · Rating 4 out of 5]

Quick and well-reasoned. Easy to follow and filled with the core of many long-standing, solid principles.

[Christopher Benassi · Rating 4 out of 5]

Really great read. Hit all the main advantages to active value investing in a "sideways" market