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How to profit like contrarian legend David Dreman
Within a couple of years many of those stockmarket darlings had plummeted back to earth. And for the fresh-faced Canadian analyst it proved to be an early lesson on the perils of market manias.
Stung by his experience, Dreman began researching the drivers of investing bubbles. He wanted to know why investors hadn’t realised that they’d been swept up in an enormous folly.
Ten years later Dreman was running his own investment firm, which at its peak was overseeing $22 billion of client funds. Today, he continues to take a leading role in his asset management firm Dreman Value Management, and still preaches the investment lessons he learned from his early days in the City.
Dreman the contrarian
Dreman's studies of the market led him to discard conventional wisdom, ignore the attraction of glamour stocks and develop his own brand of contrarian value investing. This meant hunting for shares that nobody else was interested in and deliberately acting against the prevailing market fashion.
He wants to find unloved and overlooked stocks in beaten down sectors at knock-down prices. He judged that it was precisely these sort of shares that will bounce back when the mood of the market eventually changes.
To find them, Dreman suggests focusing on the cheapest 20% of stocks in the market based on value measures like price-to-earnings, price-to-book and price-to-cash flow. He also has a contrarian high dividend yield approach.
He wrote: "I buy stocks when they are battered. I am strict with my discipline. I always buy stocks with low price-earnings (P/E) ratios, low price-to-book value ratios and higher-than-average yield. Academic studies have shown that a strategy of buying out-of-favor stocks with low P/E, price-to-book and price-to-cash flow ratios outperforms the market pretty consistently over long periods of time."
For added protection, Dreman also employed demanding fundamental analysis, preferring to buy larger company stocks with signs of earnings growth and financial strength. As soon as a company looks overvalued against the market, its price weakens or its fundamentals deteriorate, he sells it.
Ignore experts and be realistic
Dreman has written numerous books on his investing philosophies, including Contrarian Investment Strategies: The Next Generation. In it he advised investors to do away with the traditional tools of "overly optimistic" broker forecasts, technical analysis and ‘timing’ the market. Instead, he suggests being realistic about the potential downside of an investment, being patient and avoiding highly priced shares.
At Stockopedia we track four David Dreman inspired screens that apply his contrarian investing rules. Over the past two years, the low price-to-cashflow strategy takes the top spot in terms of performance, with a return of 48.7%, or 28.1% annualised. Over the same period, the FTSE 100 has returned 8.8% and the FTSE All-Share is up 10.2%.
Over the past year, the screen has particularly benefitted from positions in housebuilders like Persimmon (PSN) and Barratt Developments (BDEV), accident management company Redde (REDD) and betting company Betfair (BET).
Dreman's early lessons on the dangers of chasing up the prices of popular glamour shares proved to be a powerful way of capturing value in the market. But buying beaten-up stocks that nobody else likes can be an unpalatable prospect, especially when the market moves against you. During the internet boom in 1999 Dreman reportedly trailed the S&P 500 by 34%, only to go on and beat the index the following year by 50% when the bubble burst. So contrarianism can pay handsomely, if you’ve got the stomach for it.
Interactive Investor's Stock Screening series is written by Ed Page Croft of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.
● Interactive Investor readers can enjoy a two week free trial and £50 discount to Stockopedia using the coupon code iii014 - click here.
● To learn more about Ben Graham and his deep value investing strategies, you can download the free Stockopedia book, How to Make Money in Value Stocks.
It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.
*No fee for publication is involved between Interactive Investor and Stockopedia for this column.
About the author
Ben Hobson is Strategies Editor at Stockopedia.com. His background is in business analysis and journalism.
Ben writes regularly on investment strategy performance and screening ideas for Stockopedia. He is the author of several ebooks including "How to Make Money in Value Stocks"
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.