Contrarian Investment Strategies - The Classic Edition

I have read this book three times now, and intend to do so again. Dreman is obviously an outstanding investor, and his strategies flesh out and arguably "modernize" the techniques used by the noted fundamental investor Benjamin Graham, who was the mentor to Warren Buffett (although, I might add, this book does not emphasize the study of financial statements, which is something Benjamin Graham did in painstaking detail). Dreman's approach is most notable because of his use of investor psychology and his forceful rejection of the efficient market hypothesis. Instead, Dreman cites any number of studies and examples to support his main thesis: investors over-react to events, and those over-reactions create opportunities for savvy investors to make money. His approach involves a two-part strategy: first, preserve capital, and second, take advantage of market over-reactions to profit. His point is that the market is like a casino, but one in which the odds can favor a knowledgeable investor. In other words, no one can guarantee that a particular stock will do well, but over time, investors who follow a contrarian strategy will outperform the market generally. Dreman's approach to investing is notably different than much of what is considered "conventional" wisdom within the financial markets (for a good contrasting view, read "Expectations Investing" by Rappaport and Mauboussin). In particular, Dreman takes the position that experts err predictably and often, and that humans base decisions on a minute portion of the information thrown at them. In this respect, his skepticism differs notably from some other authors (example: Mauboussin in "More than What You Know"). From this, he demonstrates how buying low p/e, high yielding, low price/book, and low price/free cash flow stocks results in higher-than-average returns. Dreman shows how favored stocks tend to underperform the market, while out-of-favor companies tend to outperform. However, reappraisal can happen slowly, even glacially. I found this book to be both enjoyable and informative, and it inspired me to read a couple books about behavioral finance (Paulos, "A Mathematician Plays the Stock Market" and Belsky and Gilovich "Why Smart People Make Big Money Mistakes and How to Correct Them"). In all, I highly recommend this book to anyone who is interested in investing. A few other recommendations (other than those listed above) include: Klarman - "Margin of Safety" (out of print) Whitman - "The Aggressive Convervative Investor" and "Value Investing" Greenblatt - "You Can be a Stock Market Genius" (horrible title, great book) Graham - "Security Analysis" and "the Intelligent Investor" Each of these books sets forth a somewhat different approach to investing, but at the core, each of them shares a skepticism of the principals underlying the efficient market hypothesis.

"Contrarian Investment Strategies: The Next Generation" is an excellent investing book by David Dreman. Dreman mentions the stock market went nowhere for the seventeen years prior to 1982. This is a reality that many "investors" couldn't imagine, until recently. Dreman says, "Before all else, a successful strategy requires a strong defense: it must preserve your capital."Preservation of Capital is a key factor that many ride-the-hot-IPO investors missed. Many investors are seeking excitement in the "red" room of investing. In "Contrarian Investment Strategies," Dreman uses a hypothetical example of a casino with two rooms. One room, the "green" room lacks excitement, but stacks the chances of success in favor of the gambler. Few people are in the green room placing their bets, and the casino manager says it's a good thing, too, because the casino would go broke if people participated.The other room is active and exciting, but in the "red" room, the odds are stacked in favor of the casino and people tend to lose. Most investors spend their time in the "red" room of investment because they are seeking excitement. Long-term, this fails to build wealth. Dreman introduces investors to the green room of investing-- contrarian investing.Dreman shows that technical analysis doesn't work. (So, what else is new? We knew this.) But, then Dreman goes on to examine the performance of professional money managers, most of whom use fundamental analysis. After allowing for the fact that career pressures and short-term performance demands significantly affect professional stock analysts, Dreman concludes professional fundamental analysts are still bound to fail simply because the great majority of people are very incapable of effectively processing large amounts of data and coming to a meaningful and accurate conclusion about the meaning of the data.Yet, the more specific information investors are fed, the more confident they become in their predictions of a stock's behavior and value. Note, we said, they become more confident, not any more accurate. Effective securities analysis is impossible due to the scope of the endeavor. For example, Dreman casually mentions of Hewlett Packard, "In 1996, it had revenues of over $38 billion and net profit of $2.675 billion and employed 102,300 people domestically and abroad. Foreign sales in 75 countries accounted for 56% of total revenue." Do you really think you can do fundamental analysis of such a company?Dreman goes on to show that most analyst's earnings' estimates for the next upcoming quarter are usually off significantly and that valuation methods demanding precision are very dubious.Further, Dreman notes that often company earnings follow their own random walk and that you can't use the past to predict the future in today's dynamic economy.So, what's an investor to do? Take advantage of the one thing you can be certain of--the chronic overreaction of other investors. Buy out-of-favor stocks, as measured by low price

The key idea in this book constitutes sound common-sense advice to any investor: buy a diversified portfolio of out-of-favor stocks with sound underlying businesses (e.g., low P/E firms) and sell when the market recognizes their value. The book is controversial because it slams current academic theories on how the market works, especially the idea of "efficient markets". Dreman believes that simply because of the way our minds work, the market tends to systematically over-react or under-react to news (especially earnings reports), and this can be exploited forever (because the way our minds are wired is not going to change). Other controversial ideas: 1) don't buy index funds (because the committees which make indexes tend to put in firms which have had a price run-up and drop firms which have had a price decline, so that buying the index involves buying high and selling low); 2) don't buy NASDAQ stocks unless they have great volume (because NASDAQ market-makers are not regulated enough, and will cheat you on the spread); 3) avoid international (non-US) stocks (because international markets have performed much worse than the US stock market over time); 4) equities are a safer way to hold money than treasury bonds or gold or cash (because of inflation and taxes). The author presents fairly detailed statistical evidence to show that his methods have worked over the past several decades. This is actually evidence that even academics are beginning to notice.That said, it should be noted that the author's Kemper-Dreman fund (ticker: KDHAX) has done pretty badly in the last few years. Also, some of the stock picks in his Forbes column have been horrible. The most glaring example would be Prison Realty (ticker: PZN), which is currently hovering on the verge of bankruptcy. Dreman recommended it because of its REIT status and its high dividend yield both of which went away shortly after. My 2c: consider the guy's broad investment strategies with respect, but don't follow his (or anyone else's) picks without putting in your own research.

Some poo poo his ideas of basing investments on techniques that have been proven over the years. A few say the old rules do not apply, go with the flow and the fad of the day. Well, those who do not listen to the mistakes of history are bound to repeat them. I have read all of Dreman's books over many years. He has much wise advice. One tip in this book is to buy lowest p/e stock in each industry. Book is loaded with valuable statistics and ideas. Only flaw is that it is repetative, could be half as long. Buy and profit from the wisdom of the years. The historic data alone are worth the price.

As a Managing Director of Dreman Value Management, I work closely with David Dreman in managing our client accounts in accordance to the value strategy outlined in his book. Unfortunately, there are individuals who feel threatened by the robust results outlined in the book and by David Dreman's success in implementing the strategies for his clients. In contrast to claims made by these readers (1) David Dreman has been and remains one of the nation's premier stock-pickers, and has managed the top equity-income fund in the Lipper data base for the past 5 and 10 years; (2) Human nature has not changed much, but our understanding of it has, and Mr. Dreman is a leading expert on the psychology of markets; (3) The book is loaded with new and original research, covering 200 years of stock and bond returns, as well as detailed, original studies on a wide variety of contrarian strategies covering nearly 30 years and ending less than a year before the book went to press;(4) The book, which outlines David Dreman's market-beating strategies, has received universal praise from professional reviewers in such publications as Barrons, the Wall Street Journal, and the New York Times. (To see the list of more than twenty professional reviews click on "reviews" at the top left of this page.