Investment Book Review: Active Value Investing

May 10, 2010 | Comments (9)

Active Value Investing Book Review

Active Value Investing

Active Value Investing

What can You Learn in the Active Value Investing Book

Active Value Investing is written by Russian born value investor Vitaliy Katsenelson. I’ve been a reader of his blog Contrarian Edge and his content is insightful and stock analysis is wonderful. His analysis of American Express in 2008 was probably the best one out there for why AXP was cheap.

So that’s how I knew about Vitaliy, but it’s only now that I finally got around to reading his book, Active Value Investing: Making Money in Range-Bound Markets (Wiley Finance).

Range Bound Markets

The reason why it took me so long to get a copy of this book was the title “Active Value Investing” and the price tag. I figured the book would be dry and read much like a text book. Thankfully I was wrong.

The first part of Active Value Investing is all about the economic and historical performance of past markets. Before reading the book, I had always thought the market went up, down or sideways. The author expands on the idea of secular bull, bear markets as well as introducing the “range bound market” which includes bull and bear markets that trade within a range.

I’m not much of an economist or market analyst so until this book, I avoided this type of reading, but surprising, Vitaliy’s case was very clear and the supporting evidence even helped me to understand what the heck it was all about.

Active Value Investing

The rest of the Active Value Investing book is comprised of value investing concepts, fundamentals, valuation and strategy.

This second part goes through the QVG (Quality, Value, Growth) framework. It’s very much like my own spider graphs, but simplified with three axes.

Quality of an investment discusses topics such as

  • Competitive advantage
  • Management
  • Predictable earnings
  • Strong balance sheet
  • and significance of FCF

In the Growth section, the vital point made by the author is that you need to understand the company and the industry it is in to determine the growth rate. This is exactly what I preach when it comes to choosing a growth rate for the premium stock valuation calculator users. There are many engines to drive growth and while I prefer to take a conservative stance in my growth calculations, the book covers various aspects that I had not considered before.

Up to this point, I was breezing through the content but the Valuation section is what caught my attention. There are several of pages on margin of safety, diversification and discounted cash flow explanations that I skimmed through. It’s when discussions of relative and absolute valuation methods came up that really interested me.

I’m a sucker for learning new valuation methods and in the investing world, it seems like it’s mostly just refined to DCF and multiples. At least in the value investing world, we have additional methods such as Graham’s NNWC and Greenwald’s EPV.

Vitaliy provides his own method called the Absolute P/E Model.

I won’t get into the details of the absolute P/E model, but it certainly is interesting and while not perfect (what is?), it definitely is a welcome new addition to my toolbox. There is even a model to incorporate margin of safety.

I’ll eventually include this in the premium stock analysis tools and provide working examples as I grasp a better understanding of how to use it effectively.

If you can’t wait so long for me to post about it, I recommended you read this section of the book yourself.

The Process

The final chapters of the book bring everything together and deals with the process of finding ideas, buying, selling, risk and diversification.

Summary

  • Learnt more about the way the market works
  • Good review of value investing principles and fundamentals
  • Great discussion of valuation and the process of active value investing.

Get a copy of Active Value Investing: Making Money in Range-Bound Markets (Wiley Finance) through Amazon.

Disclosure

I received a complimentary copy of Active Value Investing. I was not paid to write this review. Links to Amazon are affiliate links.

About Jae Jun


Jae Jun is the founder of Old School Value. He is on a mission to provide practical and actionable value investing tools, tutorials and educational material to help empower the individual investor. Keep in touch with Jae via any of the methods linked below.

  • Zehua Zhou

    Thank you so much for the recommendation. In his analysis for AMEX, he says AXP is a financial company, thus free cash flow is a very opaque metric. Do you understand why? I am not sure why this is true.

  • http://www.oldschoolvalue.com Jae Jun

    Well the simple FCF is cash from operations – capex. With banks and financial institutions, coming up with the cash from operations is very difficult because there is no statement of cash flows.
    You don’t know how the cash if coming and going. It’s exactly why derivatives are dangerous if you don’t know what it does.

  • Zehua Zhou

    Thank you Jae. If the derivative is merely an interest hedge, I think it will be fine, right? If it is a “cash flow” hedge, then should I be concerned?
    I do see every regional bank post cash flow statements, so which financial companies are not posting cash flow statements?

  • http://www.oldschoolvalue.com Jae Jun

    My comment was more along the lines that there is no standardised cash flow statement like other non financial companies.

  • J Mako

    Hi Jae Jun,

    I read Active Value Investing and has subscribed to Vitaliy’s blog for while some time. It is an insightful book that helps me formulating my approach to investing. Vitaliy’s Absolute PE model is very interesting. I’ve been using it as a sanity check and it came pretty close to my subjective judgments. To a certain extent, it’s very similar to Graham’s formula (http://en.wikipedia.org/wiki/Benjamin_Graham_formula). But there are a couple of things I have reservations:

    - Vitaliy briefly mentions in the book one needs to adjust the formula if long-term bond yield is in abnormal range. But he doesn’t elaborate further. So, how to adjust?

    - Vitaliy uses expected growth to offset required margin of safety. (e.g. if growth is 10%, you can reduce your MoS by 10%.) This goes against the original spirit of Graham’s margin of safety. The MoS is there to protect you from making mistake and one of the easiest places to make mistake is growth projection. Using growth to offset MoS is going around in circle.

    - If you follow Vitaliy’s blog, you will notice he’s bearish on China and he has repeatedly stayed his case many times using the same set of evidences and arguments. That worries me a bit that Vitaliy suffers from “confirmation bias”. If he were open-minded on the China case, he should’ve quoted newer observations, data and evidences throughout the year, not the same thing over and over again.

    Overall, this is a great book.

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