Your book, The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere, is all about active value investing. You clearly favor an active investing approach to stay abreast of a sideways market. I just had Paul Hrabal (President of U.S. One) on the program, and he manages an ETF that invests in global index funds. His thoughts are that while the S&P may have been in a sideways market over the last 10 years, passive investors have still benefited from a worldwide net rise in equity prices in that same time period. What is your opinion of that sort of investment approach? Is it worth putting in the effort to identify individual stocks at that point? Or do you think it's just more of a question of whether we're looking at an erratically different 10 years ahead in terms of the structure of the global economy, and what we've seen in the past?

Vitaliy Katsenelson: When I talk about sideways market, I'm talking about it for all U.S. industries. So, I'm not making the argument that the global market will be in a sideways market because I haven't started that. And there's not enough data for me to make that argument anyway.

In my book, I make the argument that when you look for stocks in the United States, and if you can't find enough good stocks, the number-one thing you want to do is have more cash.

The next step is to look outside the United States for opportunities in other countries. So today, I think today over 30% of our portfolio is in European equities. If I didn't look outside of U.S., I probably would have 60% cash. Our cash is 25-30% because we have 30% invested in European equities.

So yes, I think investors should look outside of the United States, but I don't think they should necessarily look at the high-growth countries, because a lot of times, high growth, it's like the perils of growth investing. Everybody knows it's a high growth company, fully-valued, and the same thing happens with a lot of high growth countries. You're not going to get much better returns just because the country is growing faster than the stock market. But yes, I think you should look outside the United States.

You devote a couple chapters in the book to which stocks to look for in a sideways market. You talk about value, growth and quality. Could you give us a quick summary of what you're looking for in those stocks?

Vitaliy Katsenelson: I'm looking at stocks from two dimensions. Dimension number-one: quality. It's basically, what is a quality company? It's one that has a strong competitive advantage, good balance sheet, good management, high return on capital. That gives you a high-quality company.

If investors are looking for a company that's growing earnings 10% a year, to me, I would rather have a company that's growing earnings 6% a year but also pays a 4% dividend. To me, it equates the same as 10% growth.

When you can buy a company at the right price, that's when it becomes a good stock. So what is a good price? Basically, you figure out what the company is worth. Then you figure out how much margin of safety do I need? How much discount to the fair value do I need? Then you figure out, let's say you want 50% margin of safety, and it's a $10 stock – you want to buy it at $5. Then it becomes a good stock, if you price it below $5.

That's how I look at investing. My argument is, in today's environment, you want to look at high-quality companies. A high-quality company is really defined by today's global economy. I'd argue that you want to make sure that the company has a lot of cash, and has a non-cyclical business. A lot of companies that go up today are very cyclical; their performance is tied to the performance of the global economy. And the problem is a lot of these companies are very expensive.

So I'd stay away from these stocks and focus on high-quality companies that are non-cyclical. Also, for the sideways markets, you want to make sure you include your margin of safety. So in other words, instead of looking at 30% margin of safety, you want to increase it to 50%. So instead of buying a dollar at 70 cents, you maybe want to buy it for 50 cents.

Which stocks do you like right now that fit that criteria?

Vitaliy Katsenelson:A lot of stocks fall into two areas, actually.

I'll give you a health care stock, Pfizer Inc. (NYSE: PFE). [It's an] $18 stock. Pfizer has earnings power over $2 a share. So it's about eight, nine times earnings. It's gonna be debt-free relatively soon. It generates a lot of cash. Obamacare is kind of already behind us, for the most part, and has had very little impact on Pfizer's future earnings. So I can buy this company, which is going to have very stable cash flows, and who's basically trading as if they will never come out with a single new drug ever again, despite spending $10 billion on R&D every year.

Another stock is Medtronic, Inc. (NYSE: MDT), which is a device maker. They make defibrillators. What I like about this company: it has very good management [and] high return on capital. Over the last 10 years, the company grew revenues and earnings 14% a year. This company [trades at about] 10 times earnings.

No matter what happens in the economy, people get older, and therefore we're gonna use more products from Medtronic and Pfizer.

So that's health care. A couple stocks we recently bought on the technology side are Cisco Systems, Inc. (NASDAQ: CSCO), which is basically… Think about this. I was looking at AT&T (NYSE: T) and Verizon (NYSE: VZ) war over the iPhone. The thought that came to mind was that they can fight this war as much as they want. At the end of the day, they're gonna have more data traffic and more video going through Internet, and that means more and more Cisco equipment.

If you look at the numbers, it looks very appealing. It's a $110 billion market cap, they have $25 billion of net cash, so you're basically paying $85 billion for $9 billion of free cash flow. So this stock is incredibly cheap, despite having a huge tailwind behind them.

In the book you briefly touch on what you call “Religion Stocks,” ones investors chase without a lot of reason. Two that come to mind for me are Apple (NASDAQ: AAPL) and Netflix (NASDAQ: NFLX). Surely these are just as easy to find as the stocks you've been describing. Do you short these?

Vitaliy Katsenelson: I don't short. Not because I don't think people shouldn't short, it's because [my mental makeup] is not for shorting. The risk/reward, is, even if you're right, and it goes bankrupt, the most you can make is 100%. Netflix, obviously, is just overvalued; I don't think it's going to go bankrupt. But if you're wrong, the stock could double or triple on you. Some people are good at that, but it's just not for me.

A lot of the Religion Stocks of the past are very, very cheap today. Let me give you an example: Wal-Mat (NYSE: WMT). Wal-Mart basically made so much money for so many people for such a long period of time that it became a one-decision stock in the late ‘90s. You just buy Wal-Mart and never sell it. And when people buy it and don't sell it valuation becomes very, very high.

The valuation of Wal-Mart was really high; it got to 45 times earnings. Over the next decade, if you look at the Wal-Mart chat, it's basically a straight line. The reason this happened is because [the] P/E got too high.

What's kind of impressive, if you look at the earnings, Wal-Mart actually grew earnings 4% a year over the last decade. So, even though this company is huge, it's actually [having] very good performance. And now people are kind of losing their faith in Wal-Mart, and at some point it's going to be a very attractive buy.

So you have a lot of stocks like that; Medtronic was a Religion Stock at some point as well. When people lose their faith, the stocks become very cheap.

And then they become the stocks that fit the criteria that you talked about in the book?

Vitaliy Katsenelson:Exactly. There was a very good reason why they're Religion Stocks. They had a very good performance, you could relate to their brand, they were high-quality companies, they had some advantages. If the religion part became the valuation; if people are buying stocks because their parents bought them or because they've done well in the past, you're buying them on faith. That's when you have a Religion Stock.

So maybe Apple and Netflix – today's Religion Stocks – will be tomorrow's attractive buys?

Vitaliy Katsenelson:Yeah. I don't own Apple. I wish I did. I don't think I'd put Apple in the same category as Netflix. Netflix is going from one business model to another. They have done a tremendous job doing both so far.

Apple is kind of a positive black swan. It's ingenious. I'm a big Apple fan; every single time I look at them they exceed my expectations. And if you look at Apple, the stock isn't that expensive overall. Netflix is hitting 70 times earnings. Apple is hitting 16, 17 times earnings if you take out cash.