Library / Outstanding Investors

Date of review: August 2019
Book author: David Dreman
Вook published: 1979

Contrarian Investment Strategies: The Next Generation by David Dreman (1979)

David Dreman (born in 1936) is a traditional value investor who has paid particular attention to market psychology, believing that big opportunities come when markets overreact to some news or weaker macro data. He managed Dreman Value Management which he founded in 1977.

Investors are often irrational and emotional

The key message of the book is that investors are often irrational and emotional, which leads them to overreact to various events. The book has a separate section on behavioural biases with references to earlier works by Kahneman and other researchers in that field. Similar to Buffett, Lynch and other legendary investors, Dreman highlights the importance of focusing on fundamentals and the price you pay and ignore 'noise' about the direction of markets in the future, GDP changes etc.

Dreman provides a long list of famous projects made by big experts in different times, which turned out completely wrong (e.g. 'Everything that could have been invented has already been invented').

The book also has long statistical data sets suggesting that certain types of stocks outperform the market, in particular, Low PE, Low P/B, High Dividend Yields and low P/CF. Clearly, the book was written more than 20 years ago and could not capture the post 2008 period, which was completely dominated by Growth stocks.

Unlike Buffett and Lynch, Dreman suggests to invest in 20-30 stocks across 15 sectors to minimise the risks of a few companies going bankrupt and having a significant negative impact on the portfolio.

Dreman also suggests focusing on larger stocks where changes can be noticed quicker, which should lead to faster re-rating.

In financial analysis, Dreman points out the need to focus on 3 key aspects

Balance Sheet (make sure financials are sound);
Operating indicators – the higher, the better (e.g., margins, returns, turnover);
Strong earnings growth in the past and evidence that earnings will not plummet immediately.
A good opportunity could be a turnaround business in which investors benefit from both – rising earnings and expansion in PE multiple as the market rewards a growing company with a higher valuation.

Dreman also shares advice on when to buy quality companies – after a disappointing quarter when their shares tend to react more negatively than in the case of low PE stocks where expectations were low anyway. It is important to make sure, though, that a weak quarter is just a temporary issue, not a sign of a new permanent problem. Interestingly, Dreman says that there is no need to buy immediately after a plunge, there is plenty of time to do the work and buy the stock within the next 90 days (possibly even cheaper).

Finally, the book provides good evidence that stocks (measured by key market indices) are the best long-term investment option – they outperform bonds in 60% of the time in 1 year and 100% in 30 years, while even if you bought stocks at the peak of 1929, your results would still beat inflation after 15 years.

While many conclusions in the book can be found in other works, I think it has a good set of practical examples of how psychology can lead to overreactions creating highly attractive investment opportunities.

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