Book review: David Dreman – Contrarian Investment Strategies – The Classic Edition

David Dreman is quite famous as one of the original “contrarian” investors using a formula approach. Similar to other “formula” investors, he dismisses all kind of active forecasting, fundamental analysis, chart reading etc.

In the book, he first presents over around 150 pages (more or less) convincing arguments, why all other approaches are doomed to fail, mostly due to behavioural finance biases. Much of that is now common wisdom but I guess when he wrote his first books this was fairly new.

In the next part he then present his “one and only” strategies, mainly to invest in the:

– lowest P/E stocks
– lowest P/B stocks
– lowest P/CF stocks
– lowest P/Dividend stocks

He advises to hold at least 20-30 different stocks from different industries and against small caps.

His strategies are based on a 26 year dataset (1970-1996).

Interestingly, he then “dilutes” his own low P/E strategy by applying additional indicators, such as

– “strong” financial position
– “as many favourable operating and financial ratios as possible”
– higher past earnings growth than S&P and “likelihood that it will not plummet in the future”
– conservative accounting
– above market dividend yield which can be sustained

In my opinion,this is the weakest point in the book. Before he spends hundred of pages arguing against “judgements” in the stock selection process, but then he basically admits that a low P/E strategy itself does not help a lot and you need to spice it up with fundamental analysis and subjective assumptions about the future.

In the final chapters, he then looks at market bubbles, IPOS etc.

Summary:

I personally cannot really recommend this book. Although there is a lot of good stuff in it, I would say there are much better book about all the topics covered in the book.

For instance, O’Shaugnessy’s “What works on Wall street” is much better at backtesting formula strategies (and by the way dismissing simple P/E and P/B strategies).

Also on behavioural finance, for instance “The little book of behavioural Finance” from James Montier is much better structured.

My major point however with this book is the following: I am very wary if any author recommends his strategy as the best strategy for EVERY investor. In my experience, many strategies, even based on charts,momentum etc. can lead to success. The major point is that the strategy has to fit to the character of the investor, otherwise one will never have the energy and stamina to follow those strategies over bad times which will happen to ANY strategy.

Personally, I use a strategy very similar to Dreman’s but i would definitely not recommend this vor each and everyone. Going against the crowd sounds easy but it is not.

9 comments

  • #welju,

    interessanterweise ist ja bei O’S das Kriterium Momentum sehr signifikant.

    Dennoch bleibe ich skeptisch gegenüber “Formula Investing”….

    MMI

  • Im Gegensatz zu O’Shaughnessy betont Dreman, dass typischerweise die “besten” Investments über- und die “schlechtesten” unterbewertet werden (Überreaktionen) und dass Aktien, die relativ unbeliebt sind, kaum auf negative Überraschungen reagieren, während beliebte Aktien kaum auf positive Überraschungen ansprechen. Aus beidem resultiert m. E. auch die Stärke des Dremanschen Ansatzes.
    Bei “Value” geht es nicht nur um das mechanische Erfassen von Kennziffern, sondern auch darum, die Gründe für Marktbewertungen zu verstehen und unter welchen Voraussetzungen sich im Einzelfall jene Bewertungen ändern könnten.

  • In practice it’s easy, too.
    IF you follow the book 😉

    But, here to see, even for the author, it’s awfullly hard to follow his own rules.

  • settla

    this was exactly my thinking. In theory contrarian investment is easy and backtested results look always good (datamining).

    Maybe he got “over confident” ? That would be my interpretation of a lveraged portfolio with a 10% position in one stock.

    mmi

  • Judging O’Shaughnessy’s (or any others’) funds by two years’ performance is a bit unfair, in my opinion.

    What a coincidence, I’ve been reading this book on the day you did your post, mmi. I didn’t find it quite that bad, only a bit (ok, a lot!) drawn-out. As Howard Marks would have put it, “he wanted his book to have lots and lots of pages, and he succeeded”. A little “distilling” would have really helped.

    But, thanks to derivatus, this really is an absolutely fascinating example of how smart people do dumb things. After reading his book, i got away with the thought that Mr. Dreman isn’t really that dumb. Actually, i found him quite knowledgable, especially his knowledge of fin’l history, which is so important for investors.

    Yet, he managed to blow up. And – if you look at the funds’ report – he did so by throwing his books’ rules out of the window! So he knew, but he didn’t do!

    In the book, he explains how they went along investing in regional banks during the 1990 banking crisis. “if you’re conservative, you want to guard against risk. The best way is to have adequate diversification. As a money manager, I did this by buying a fairly large number of banks, with none accounting for more than 2% of our overall holdings”.

    And then he invested 10% in Fannie Mae in 2008…

    Not to speak of leverage. If you look at the funds’ report, it blows your mind. Weren’t the underlying holdings leveraged enough for his taste? 😉

    Doesn’t it absolutely blow you away that someone who thinks so consciously about what works in investing (and writes it all down! Which should cement those good thoughts even more in his head) in the next instance just turns around and does things just the opposite?

    In the beginning of the book he quotes Napoleon. “I leave nothing to chance”. What a quote!
    Why doesn’t he follow through?

    His theories are worth your money, his practical abilities apparently not.

  • one additional comment: Interestingly, O’Shaugnessy’s fund arent that top notch either.

    http://www.osfunds.com/MF_all_cap_core.aspx

  • Its always nice if a writer manages money and has a public record.

    In his 2008 report for the Dreman Claymore Dividend Fund (DCS)
    David Dreman writes on page3, 3rd chapter:

    …. For the 12-month period ending October 31, 2008, the
    Fund returned –83.31% and –81.30% based on market price and NAV, respectively….

    http://www.guggenheimfunds.com/libraries/literature_en/dcs_annual_20081031.pdf

    Since then he sold his asset company and founded a new one.

    http://www.dreman.com

    Ein neues Spiel ein neues Glueck ?

    • derivatus

      thanks for the link. ZThis clearly shows the disadvantage of “formula” investing.

      It looks like he got caught in financials which for the now well known reasons did not mean revert.

      Interestingly enough a lot of the “automated” strategies now simply exclude financials which in my opnion makes them questionable anyway.

      MMI

  • Good review.

    The book has got a lot of good ideas for the reader to develop an investment strategy that suits him or her best.

    His research on why you should avoid forecasts is worth a read.

    As you say contrarian investing is hard, especially if you hit a few value traps.

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