🎙️ Interview Vitaliy Katsenelson
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Do you know Vitaliy Katsenelson?
He’s a great friend and one of the best value investors I know.
In today’s interview, you’ll learn more about his investment philosophy.
I hope it will allow you to become a better investor as well.
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🎙️ Interview Vitaliy Katsenelson
Compounding Quality: How would you define yourself as an investor?
Vitaliy Katsenelson: I think of myself as an eclectic value investor with a slight touch of dogmatism.
Let’s start with the eclectic part.
Our portfolio doesn’t look like a traditional value portfolio — it doesn’t fit neatly into a quadrant of any box. Undervalued companies come in different sizes, not all are in the US. We own companies all over the developed world.
Not all undervalued companies look “in your face” statistically cheap (something you’d expect to see in a “by the book” value portfolio). Some of them are even considered to be growth stocks and thus trade at growth multiples.
But our portfolio is constructed using the values of value investing — each company is valued with the same care as if we were buying the whole business and demanding a margin of safety. In other words, we buy only stocks when we believe they are undervalued.
What is the difference between cheapness and undervaluation? Statistical cheapness is often easy to see: A company that trades at 7 times last year’s earnings is considered cheap, but it may or may not be undervalued. Though it may appear to be cheap based on rear-view-mirror earnings, it won’t be cheap if its earnings collapse in the future.
Compounding Quality: Where does the touch of dogmatism come in?
Vitaliy Katsenelson: Your investment process should bring out the best in you and play to your strengths. It should fit your personality. It should amplify your strengths and reduce the impact of your weaknesses.
Investing is a very different endeavor from other professions. Let’s contrast it with being an orthopedic surgeon. You are an orthopedic surgeon, and you discover that for whatever reason, your success rate for surgeries on right knees is much higher than for left knees. There is however very little you can do with this knowledge. It will be impossible for you to build a practice focused solely on right knees.
However, if you’re an investor, you have more flexibility. At IMA, I need a portfolio of only 25 to 30 stocks. There are thousands of stocks in the developed world. After careful observation of my past decisions — something every investor should do — I found that I have the worst IQ (intelligence quotient) and EQ '(emotional quotient) when it comes to retail stocks. They are my “left knees”. But this is the beauty of investing — I can build a portfolio that does not include retail stocks. Therefore, being mindful and deliberate and figuring out what your “left knees” are is essential. Focusing on “right knees” is what every investor should do. Well, at least, this is what we do.
This brings me to quality. Through painful experiences, I found that my EQ is the highest when we own high-quality businesses. There is nothing wrong with owning low-quality businesses; some investors are very good at doing that. I don’t look at my desire to own high-quality businesses run by good management as a badge of honor — it’s just the strategy that fits my EQ and IQ. Again, trying to play to my strengths.
Compounding Quality: You live classical music. Is there a similarity between classical music and investing for you?
Vitaliy Katsenelson: The output of art touches your heart, whereas the output of investing lands in your wallet.
I did not start listening and writing about classical music because I thought it would make me a better investor. I stumbled into writing about it for no other reason other than that I love listening to it. I wanted to learn more about it. Some people play instruments; I don’t. Writing was my way of getting closer to this amazing music.
What I found is that creating classical music and the investing process have similarities. The parallel, the connective tissue, between making classical music and investing is creativity.
Most people don’t think of investing as a creative activity. Numbers, financial statements, and spreadsheets are usually not the hallmarks of creativity. In fact, they are usually considered antithetical to creativity.
Finding new, often different ways to look at what everyone else is looking at is creativity.
Composing music and investing requires access to the supercomputer of the subconscious mind. They are nonlinear activities — input and output are not directly, but rather loosely, connected — and they bring a lot of creative joy with them. There is also a lot of creative pain in both, as well as the pain of failure. In my book Soul in the Game, I wrote about painful periods in my investing career and compared them to what Rachmaninoff struggled with in creating his first symphony.
Compounding Quality: What’s the difference between skin in the game and soul in the game?
Vitaliy Katsenelson: Skin in the game means experiencing not only the benefits of the upsides but also the pain of the downsides of your decisions. An engineer standing confidently underneath the bridge he built when the first semi-truck rolls over it is one example. Another example is a cook eating their own cooking. If I noticed a sushi chef mostly eating maki sushi at any other establishment besides the one where he worked, I would question his skin in the game and thus the quality of the meal he prepared for me.
Soul in the game is the next level of evolution of skin in the game.
It’s the waiter in the restaurant who made you feel special, who showed true care for you. It’s the car mechanic who earned your unconditional trust. It’s an employee who deeply cares about the success of the firm and clients’ happiness. It’s a sushi chef who is obsessed with making the best sushi in the world. We recognize these people in an instant when they enter our lives.
People who have soul in the game are not just driven by money or other people’s regard for them; the satisfaction of having a positive impact on people is its own reward for them.
An auto mechanic who does a great job on your car and does not make you pay for unnecessary work is not an altruist. He gets satisfaction from making others’ lives better. He may give up some extra income with his behavior because money is secondary to him. Yet, the pride he feels from an honest job, well done, is part of his own reward.
Someone who has soul in the game is profoundly in alignment — they deeply care about what they do, they have pride in their work, and they derive meaning and satisfaction from their work.
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Compounding Quality: What’s the best investment decision you’ve ever made?
Vitaliy Katsenelson: From a personal, creative satisfaction perspective, our investment in Uber was one of our best. That’s not to say that it has been the most successful decision from a financial perspective, at least not yet.
Uber doesn’t fit into the traditional value stock category. Until 2023, the third year of our ownership, it never made money. It probably had lost more money up to that point than socialism has. It was a stock everyone hated. After we bought it, I had clients reach out to me asking if I had been kidnapped and if someone else was making these purchases of Uber.
We bought more shares very opportunistically during and after the pandemic. I wrote a long research report on it, which you can read here. My thesis consisted of several insights.
First, unlike traditional tech, digital-only companies, Uber is a hybrid, both digital and analog. Thus, its cost structure is much higher than that of other companies. This, in part, explains the higher losses.
Second, it has a strong brand; its name has become a verb.
Third, the rideshare market is inevitable and will only continue to grow. Uber is not just in competition with taxis, second cars, or seldomly used cars; it is also in competition with the favors we ask of friends and relatives, such as dropping us off at the mechanic or picking us up from the doctor’s office.
Fourth, Uber has a global scale, which its competitors lack, allowing it to spread R&D across more markets.
Finally, as its revenue grows, each incremental dollar comes with a very high margin, which directly drops to the bottom line. Therefore, at some point, its earnings will explode to the upside as fixed costs stop growing, allowing it to scale.
The Uber story is not over; we still own the stock. I don’t want to do a celebratory dance. But this idea came with a lot of creative satisfaction. There is another point of pride here. Despite our very tumultuous ownership of this stock, we remained rational. We bought more when it became extremely undervalued, and I would be lying if I said that was psychologically easy — it was not, but we followed our research and process.
Compounding Quality: What’s the worst investment decision you’ve ever made?
Vitaliy Katsenelson: My worst investments that resulted in losses had several things in common: They were low-quality companies; their financials were complex and not transparent; and they had questionable management. However, they were all considered “cheap” — until they were not.
When you are wrong on an investment and lose money, the most you can lose is 100%. I have learned a lot from those. But they were not my worst investments. Those were the ones where I left 300–400% on the table when I sold too soon. Let me give you an example.
We bought EA — Electronic Arts — in the early 2010s. At the time, games were moving from being sold in stores to being digital downloads, which would lead to higher margins. The market for games was exploding, as every adult and teenager had a gaming device in their hands — a smartphone. The market for video games was going to be much larger. EA was the largest player in that space, with great franchises.
The following two years of ownership were very painful. EA had a few big game flops, and the market did not care about improving fundamentals. The stock kept declining. We continued to buy more. Every time we bought more shares, the stock fell further. Fast-forward a year or two. The stock doubled from our original purchase. But I was mentally exhausted. I did a celebratory dance and sold the stock. The stock then went up another 4x within a few years after we sold it. It went up for the right reasons — its earnings exploded to the upside, in line with my original thesis.
The sale was a mistake, not because the price went up but because I let frustration over the stock price decline (volatility) get to me. Investing is a mental game. I learned from this adventure that it is important to zoom out and not obsess over individual stocks in the portfolio. This is why we have a portfolio. It was a very costly but educational mistake. Our ownership of Uber was not a walk in the park, either — just look at the stock price over the last few years. But I had learned my lesson from EA and was able to do the analysis, update our model, and zoom out.
🎙️Interviews
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Soon, part 2 of Vitaliy’s interview will be published.
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Used sources
Interactive Brokers: Portfolio data and executing all transactions
Finchat: Financial data