Customer Reviews

Contrarian Investment Strategies - The Next Generation

5 star:		(29)
4 star:		(10)
3 star:		(8)
2 star:		(2)
1 star:		(4)

 

 

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.

This is one of perhaps a handful of books the value-oriented investor will likely find indispensable. The book's indispensability is a product of something for which David Dreman deserves great accolades: his apparent monopoly on an expansive array of statistics --statistics to support buying stocks when they are inexpensive in several different respects, statistics to support the avoidance of stocks priced to perfection, and statistics to support the pathetic fallacy of entrusting valuations and earnings estimates to investment house analysts. The stats compiled by Dreman concerning the latter, especially earnings estimates and a particular issue's probability of meeting these estimates over serial quarters, are particularly impressive and sobering. At the very least, all of these statistics serve as a validation for what the value investor has at least accepted intuitively. Yet the reader will probably also derive new ways of looking at securities from a value perspective. (Incidentally, readers who are expecting a rehash of the Tweedy Browne value studies will be pleasantly surprised...)

The two additional sections of the book concern investment strategy and investment psychology. Regarding the former, it is hard to cover strategy satisfactorily in value investing without discussing valuation itself. The central challenge of the value approach is distinguishing what's compellingly cheap from what's cheap for compelling reason. But here Dreman directs readers to other resources, and coyly suggests buying whatever has the largest number of attractive financial ratios. Thus the newcomer to these approaches will likely have ample reading and work to do if he/she really wishes to seriously embrace the task of finding "oversold" securities.

The investment psychology section is useful, but could probably be reduced by half. In fact, Dreman's essential shortcoming is his tendency to bludgeon the reader with the same thought, cloaked slightly differently, several hundred times. Of course, in the world of investment literature, there are worse things than relentless proscriptions against doing stupid things in the marketplace.

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.

The author fails to persuade that his system can really be successfully implemented by the average investor, even assuming one with the requisite resources and endurance to own and manage a 30-40 stock portfolio. Interestingly, his own fund has failed to beat the S&P 500 Index over the last 10 years -- despite his statistics that low PE stocks outpace the market 99% of the time over ten-year periods. Perhaps there is a "slight" problem in actually implementing his strategy even by a mutual fund that charges a steep sales load and a better than 1% annual expense ratio. With those kind of charges, why couldn't the author figure out and implement a low cost index-like stategy as he suggests in his book. Too bad that such fertile thinkers as Dreman and O'Shaughnessy (What Works on Wall Street) can't duplicate the theoretical success of backtesting data in the real world of mutual funds. Is it perhaps that they fall victim to some of the very traps that they discuss in their books - not sticking to mechanical application of the odds based on the data.

His belabored (and often confusing) critique of the efficient market theory and randomness of price movements appears to be less than convincing given his own fund's performance over the last 10 years. I'm still waiting for a low cost index-like approach from the mutual fund industry with true market-beating performance using the allegedly can't miss strategies from data mining researchers. Until then, stick with a super low cost diversified portfolio of index funds from Vanguard.

At least Dreman provides data to suggest that holding periods longer than one year don't hurt performance in his models, assuming they work at all. Also his take on the superiority of stocks vs. bonds and the definition of risk for long-term investors are helpful.

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.

There are many interesting ideas in this book. However, this book could have been half its 400+ page length and been much more effective. There are sections through the middle of this book where Dreman repeats himself for 20+ pages. Where was the editor?

Having said that, the notion that there is an excess return attributable to contrarian investing is a useful and powerful notion. I would take exception with his definition of contrarian. A contrarian is someone who goes against conventional wisdom and popular ideas. That is not the same strategy over time. At the time of the writing of this book, buying low P/E, low P/Book Value, etc. stocks was a contrarian strategy. However, it is not necessarily always so. Value investing has come into vogue since the bursting of the tech bubble. The US market currently has a historically small spread between the lowest and highest PE sectors in the market. That is not a market that is dramatically discounting low P/E vs. high. It seems unlikely to me that situation will lead to larger than market returns for low PE stocks right now.

The section on small cap stocks was outstanding. Dreman shreds the studies that claim small cap stocks have significantly outperform large caps. In fact, what he convincingly shows is that small cap low P/E stocks are the best historical investment. However, as always, past performance is no guarantee of future results.

One final caveat, Dreman exhaustively cites statistics supporting low P/E investing. He then recommends modifying the strategy in ways that he has not tested statistically. He shows compellingly that low P/E small caps historically outperformed. He then suggests that we only buy stocks in that category with strong balance sheets and large dividend yields. He never tested that strategy and has no evidence to support it as it is distinct from the strategy tested.

All told this is a good book to get one thinking differently from the crowd, a very good thing. However, be careful taking everything in this book at face value.

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.

Dreman makes a persuasive case here that the financial experts and analysts as well as the average investor are terrible in predicting which way the stock market is going. If you want to beat the market, you need to do the opposite of everyone else, by investing in currently out-of-favor value stocks with low P/E ratios.

To his credit, Dreman correctly forecast the big market crash of 2000-2002. Published in 1998, Dreman here observed that the market of the late 90's was way overpriced and that a major correction was in the works. He was correct, although the crash was 2 years off when this was published.

His whipping boy in this book, as in almost every other investing book on the shelves, is the Efficient Market Hypothesis (EMH). But in truth, his investing strategy does not contradict EMH. In its simplest form, EMH argues that, statistically speaking, the past movements of a stock have no significant relationship to its future movements. Dreman indeed agrees with this, and the assertion has never been disproved.

Dreman has lots of fun poking fun at the assertion of EMH that investors are rational and that current stock prices reflect all known information about the company. But the claim that investors are rational is not really controversial: all it adds up to is that investors seek to maximize returns and avoid losing money. Investors may act for poor reasons, but there is always a reason for the movement of a stock. There are good and poor reasons, but those only emerge in hindsight.

Dreman also says that Beta is completely worthless as a measure of risk and returns, and that may be true for individual stocks, but for mutual funds it's very useful. The Beta for a small-cap fund will be significantly higher than a large-cap value fund, and investors are generally rewarded for taking on that risk, at least in the long run.

All but the most extreme forms of EMH accept that stocks may be undervalued or overvalued *in the short run.* In the long run, the market is in fact completely rational. If it wasn't, there would be no point in investing in the market at all, since stock movements would be completely random. And if there are temporary irrationalities in stock prices, then it follows that investors can profit from those under- or overvaluations. Some theorists argue that it's not wise to try to beat the market, but most EMH theorists advocate a value strategy identical to Dreman's. See for example Larry Swedroe's excellent "The Only Guide to a Winning Investment Strategy You'll Ever Need."

I was bummed out before I read this book- had just read A Random Walk Down Wall Street and had become a believer in a)the efficient market hypothesis and b)the inability to beat the market over the long term.

Then comes this book. Chapter by chapter, Dreman dissects efficient market arguments that I saw as fact and showed that they were folly. Dreman states that the market is not efficient because investors are many times not rational. In fact, they are predictably irrational. And then Dreman gives data to prove this. He presents research to show that investing in a certain way allows you to beat the market.

And he gives more research and data. And more, and more. Some people will complain that this is boring and overwhelming, but he does so to prove the validity of his methods. I've read many investment books, and usually an author will give his guidelines for picking stocks, with return numbers taken at a certain point in time, and holding stocks for a certain period, and maybe a few other stipulations. And in the end, I never trusted the author enough to invest any real money in his strategy.

Not so with Dreman. The wealth of research convinced me that Dremans methods were not datamining and were not limited to certain market environments.

Its the most imporant investing book I have read. Dremans method is very similiar to value investing preached by a number of other famous investors. The difference is that Dreman proves to you through his research that value investing works. Everybody addicted to Mad Money and Jim Cramer needs to give this book a peek.

There are a lot of fads that come and go in the investment world. There are very few of them that pass the test of time or make absolute sense. David Dreman brings clarity to one such strategy: low PE and value investing. It is found in his new book, "Contrarian Investment Strategy: The Next Generation." David Dreman's investment strategy should be the "baseline" to judge the merits of all others. His book is a must read for the serious investor. - Clay B. Mansfield, former Chief Investment Officer of The Pennsylvania Public School Employee's Retirement System.