Contrarian investors believe that people who say the market is going up do so only when they are fully invested and have no further purchasing power. At this point, the market is at a peak. So, when people predict a downturn, they have already sold out, and the market can only go up at this point. The principles behind contrarian investing can be applied to individual stocks, an industry as a whole or even entire markets. A contrarian investor enters the market when others are feeling negative about it. According to David Dreman, contrarian investor and author of Contrarian Investment Strategies: The Next Generation , investors overreact to news developments and overprice "hot" stocks and underestimate the earnings of distressed stocks.
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This article on David Dreman was written by Colin Richardson. Colin is a private investor based in Alberta, Canada. When you search the word contrarian in the dictionary, a high-quality image of David Dreman should display prominently beside the definition. If your dictionary is flawed and does not have his portrait, then you should at least have his description — a person who opposes or rejects popular opinion, especially in stock exchange dealing.
Dreman has written five books, four of which have the words contrarian investment in the title. David Dreman knows how to play the stock market. How does he value companies? Does he has any book recommendations for the individual investor?
David Dreman was born on the first day of in Winnipeg, Manitoba, Canada. Investing was in his blood, as his father — Joseph Dreman — traded commodities for a living. In the late s, Dreman packed his bags and moved to New York for a year to study the American markets. As Dreman discovered, this was only the start of a long journey ahead. I worked at Value Line at the time, and we thought were going to make millions; we thought it would never end.
Being young, you thought it was easy to make money, but the people around us who were more experienced in bubbles knew we were going to get hurt. They were right. My friends pretty much lost their profits; I was a little luckier because I remembered some of my Graham and Dodd. When the markets went down, I got hurt, but I still came out with some money.
Dreman describes himself as getting a little lucky during the go-go bubble stock market crash. Although he did implement some teachings provided by Benjamin Graham and David Dodd , this was not enough. With such a significant impact, it must have been difficult for him to trust the stock market.
Dreman continued on his journey, but not without making some changes to his investment approach. These changes — such as becoming contrarian — would eventually lead Dreman to being the remarkable investor he is today. However, the strategy could have a broad range of interpretations. Being contrarian simply means to believe and follow an investment approach that is different from the majority.
The reason this belief is considered contrarian — different than the rest — is because of the popular efficient market hypothesis EMH. That meant that stock prices are determined by the thorough and diligent work of the brightest analysts, money managers, and other investors … The hypothesis has been so widely accepted in academic circles and on Wall Street that several of its leading proponents have received Nobel Prizes for their contributions.
If you want to achieve market-beating returns, the first step is to become a contrarian. However, the idea of ignoring award-winning academics is easier said than done. Thankfully, the contrarian himself provides us with some insight:. Sure, the methods are easy to understand and initiate.
But most investors, whether professional or individual, even with the best intentions cannot follow through. This is almost too good to be true. The only challenging part is following through and trusting the strategy.
Dreman first began sharing his simple investment strategy over 40 years ago, yet even today they are still considered contrarian. It would be safe to assume Dreman has no problem ignoring the academic circles. However, Dreman is very confident that will never happen.
His confidence stems from many years of studying the single factor that controls the markets — investor psychology. This is the reason why most people cannot use these strategies even though they are known to have provided superior results for years.
Many books and studies have been published on investor psychology. Often called biases or heuristics, these forces often lead investors in the wrong direction. These errors are so systematic that the knowledgeable investor can take advantage of them. It is upon this behaviour that my contrarian strategies are founded. We are all susceptible to multiple biases or errors. It is important for contrarians to educate themselves on investor psychology.
As Dreman notes, these errors are so systematic that even being aware of them will give an investor an advantage. Along with EMH, Dreman also has scrutinized another popular investment approach called technical analysis.
Dreman believes these investors fall for a psychological bias by attempting to achieve the impossible. These techniques can only cost you money.
The error is rather obvious once David Dreman make us aware of it. Those who have tried technical analysis may feel foolish. They somehow believe that by drawing some lines on a chart or backtesting an indicator, they have created a crystal ball to predict the future.
No person or computer knows what will happen next in the markets. David Dreman does not use technical analysis to pick winning stocks. He uses the opposite — fundamental analysis. He has proven that every company has key ratios that can be calculated to find stocks with the highest chance of success.
Start by screening for companies with low price-to-earnings, low price-to-book, and low price-to-cash flow. Dreman has found that over time, these companies have a higher probability of increased performance.
But all three strategies handily beat the market and sharply outperform the best stock in each case. For those who have extra time on their hands and want to evaluate companies further, Dreman provides five more pieces of criteria. These characteristics have been found in companies that have outperformed over time. Indicator 2. As many favorable operating and financial ratios as possible.
Indicator 3. Indicator 4. Earnings estimates should always lean to the conservative side. Indicator 5. Once you have screened out the most favourable companies, Dreman recommends building a portfolio of 20 to 30 stocks.
Some investors may begin to wonder how risky a portfolio of 20 to 30 stocks with strong value indicators is. Unfortunately, one can interpret this question many different ways. The investing world regularly debates the definition of risk. Possibly you accept these measures without question. Most people do. But in truth they are faulty. In the first place it has been known for decades that there is no correlation between risk, as the academics define it, and return.
Higher volatility does not give better results, nor low volatility worse. It should come as no surprise to learn that David Dreman has a contrarian perspective on risk. His concerns are legitimate, as many other researchers have found zero correlation between risk and return.
As Dreman explains, a definition of risk must incorporate two key factors. The probability the investments you select will outperform alternative investments for this period. With the high returns the portfolio will produce, it is unlikely any alternative investments will outperform. Every great investor has an addiction for reading books. Fortunately, Dreman provided some suggestions for an individual investor.
He has hidden in the shadows from the majority of the investing world, but those who decided to recognize Dreman and learn from his teachings greatly improved their investment strategy. We value investors are so fortunate to learn from Dreman and his experiences. It is not often that such a successful professional is willing to share their secrets.
Seth Klarman achieved one of the best long term investment records of all time. Get the key insights that helped Klarman excel at his craft, and stay up to date with what's happening at Broken Leg Investing. Table of Contents. First Name. Email Address.
Contrarian Investment Strategies: The Next Generation
Investing Book Summaries. The complete opposite of their prophecies are often what plays out. Hence, David explains that these experts are extremely skilled at being wrong. Furthermore, analysts are often blacklisted from receiving information from companies that they have granted a sell recommendation. For these reasons, there are 7 times as many buy recommendations than there are sell recommendations. Increase that streak to 10 quarters in a row, and your chances are 1 to ,
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Contrarian Investment Strategies: The Classic Edition
David Dreman, author and money manager, wrote one of the seminal books on contrarian investing, "Contrarian Investment Strategies: The Next Generation". We've studied, extracted and computerized the methodology allowing stocks to be screened and ranked based on the value method. A contrarian style of investing has had a tough run since the financial crisis, but that could lead to an interesting opportunity when value stocks eventually turn. It almost always has to do with the fact that they're able to make good decisions and be correctly contrarian in adversity.