Exclusive Interview With Vitaliy Katsenelson (PFE, VOD)

Vitaliy Katsenelson, who is a research director at Investment Management Associates and contrarianedge.com, was nice enough to grant me an expansive interview. Vitaliy is known for his value investing style and his book Active Value Investing: Making Money in Range-Bound Markets (Wiley, 2007). He also has been published in the Financial Times, Barrons, BusinessWeek and The New York Post. In addition, Vitaliy appeared on CNBC last week, you can see his comments here. We talked about a wide variety of market specific and economic topics, including his investment style, the future of the U.S. Dollar, Japan, China, the U.S. equity markets, and specific stock picks.

Investment Style

Vitaliy is a value manager who draws his philosophy and techniques from the teachings of Benjamin Graham. Essentially, he looks for stocks that are undervalued compared to the intrinsic value of the entire company. Other specific factors that Vitaliy looks for in companies include sustainable competitive advantages, predictable earnings, highly capable management teams, and a record of generating a high return on capital. One thing that Vitaliy stressed about his style is that unlike many value investors, he does not blindly follow a buy and hold strategy. Rather, he sells stocks when they have reached fair value. In other words, it is immaterial to his strategy if it takes five days or five years for the market to recognize a security’s true value (though if he holds it for five years he wants to get compensated for holding through growing earnings and dividends). He told me that if he bought a stock today and it appreciated 50% tomorrow, and he felt that it was now properly valued, he would go ahead and sell it.

Outlook For U.S. Dollar

I was curious to find out what Vitaliy thought about the recent strength in the U.S. Dollar. He told me that right now the dollar is “the best house in a bad neighborhood” and that it should continue to benefit from investor risk aversion in the near term. In particular, he does not think the Yen or the Euro will rise substantially against the dollar.

Japan

One theme that Vitaliy feels very strong about is the debt problems in Japan. Currently, Japan’s debt exceeds its GDP by a whopping 197%. This is by far the highest ratio in the developed world. Famed value manager David Einhorn of Greenlight Capital has also spoken about this investment thesis in recent months. The likely consequences of this debt crisis are going to be much higher interest rates in Japan and a weakening of the Yen. Although the exact timing of the coming tsunami may be difficult to pinpoint, prudent investors should avoid any investments that could be negatively effected by rising rates in Japan and a falling Yen. A more detailed analysis can be found here.

China

Vitaliy’s opinion on the Chinese economy should give investors who are bullish on global growth cause for concern. The near term outlook for the country arouses significant divergence of opinion among market observers, and Vitaliy is decidedly in the bear camp. He argues that there is significant overcapacity in the Chinese commercial and residential real estate market and the industrial sector. The likely consequences of this are decreased Chinese demand for industrial, energy, and commodity goods. Furthermore, if Vitaliy is correct, the central government has been exaggerating GDP figures (during the financial crisis) and China faces lower future growth prospects as it has tremendous overcapacity in real estate (both commercial and residential) and industrial sectors. You can find a more thorough presentation of his thesis here.

U.S. Equity Markets And Specific Stock Recommendations

Vitaliy told me that he is neither a bull nor a bear, and tries to always maintain an open mind with regard to market sentiment. That being said, he does not believe that the stock market is cheap at current levels. In fact, he has Sell and Hold ratings on a majority of the stocks that he follows. There are a number of stocks that he is bullish on, however, including Pfizer (NYSE: PFE) and Vodafone PLC (NASDAQ: VOD). Both of these names are large cap companies that are trading at compelling valuations. Vitaliy said that Pfizer’s (PFE) stock price has been suffering recently because the pharmaceutical giant has a lot of drugs coming off of patent in the near future. According to his analysis, however, even if sales of drugs that face expirations were to decline 90% and Pfizer would not come out with a single new drug ever again, the shares still would have a value of over $20. Right now, the market is only valuing Pfizer’s stock at $17.69.

The other name that Vitaliy likes is Vodafone (VOD). This company is based in the United Kingdom and trades as an ADR on the Nasdaq exchange. Vitaliy said that right now the market is valuing Vodafone’s 45% stake in Verizon Wireless at essentially $0, when in fact it is worth around $45 billion, at least. Vodafone also has a very healthy dividend yield at current prices. As of February 25, VOD shares were trading at $22.00.