David Dreman, Contrarian Investment Strategies – The Classic Edition

David Dreman's name is synonymous with the term "contrarian investing," and his contrarian strategies have been proven winners year after year. His techniques have spawned countless imitators, most of whom pay lip service to the buzzword "contrarian," but few can match his performance. His Kemper-Dreman High Return Fund has been the leader since its inception in 1988 — the number one equity-income fund among all 208 ranked by Lipper Analytical Services, Inc. Dreman is also one of a handful of money managers whose clients have beaten the runaway market over the past five, ten, and fifteen years.
Now, as the longest bull market in the history of the stock market winds down, there is increasing volatility and a great deal of uncertainty. This is the climate that tests the mettle of the pros, the worries of the average investor, and the success of David Dreman's brilliant new strategies for the next millennium.
Contrarian Investment Strategies: The Next Generation shows investors how to outperform professional money managers and profit from potential Wall Street panics — all in Dreman's trademark style, which The New York Times calls "witty and clear as a silver bell." Dreman reveals a proven, systematic, and safe way to beat the market by buying stocks of good companies when they are currently out of favor. At the heart of his book is a fundamental psychological insight: investors overreact. Dreman demonstrates how investors consistently overvalue the so-called "best" stocks and undervalue the so-called "worst" stocks, and how earnings and other surprises affect the best and worst stocks in opposite ways. Since surprises are a way of life in the market, Dreman shows you how to profit from these surprises with his ingenious new techniques, most of which have been developed in the nineties. You'll learn:
• Why contrarian stocks offer extra protection in bear markets, as well as delivering superior returns when the bull roars.
• Why a high dividend yield is just as important for the aggressive investor as it is for "widows and orphans."
• Why owning Treasury bills and government bonds — the "safest investments" for centuries — is like being fully margined at the top of the 1929 market.
• Why Initial Public Offerings are a guaranteed loser's game.
• Why you should avoid Nasdaq ("the market of the next hundred years") like the plague.
• Why crisis, panic, and even market downturns are the contrarian investor's best friend.
• Why the chances of hitting a home run using the Street's best research are worse than being the big winner in the New York State Lottery.

Based on cutting-edge research and irrefutable statistics, David Dreman's revolutionary techniques will benefit professionals and laymen alike.


© Reprinted by permission. All rights reserved.

Chapter 1

The Sure Thing Almost Nobody Plays

Imagine you are entering a deluxe, well-appointed casino. Off the lavish entry foyer, there are two ample gambling wings, one hued in reds, the other in muted greens. The red wing looks enticing, but if I may insist, let's first enter the less crowded green rooms to watch the action.

The atmosphere is unhurried, the blackjack tables are sparsely attended, and every player sits behind a mound of green and black chips. You think at first you've come to the wrong place. You see the ordinary table limits, the ordinary clothes, the ordinary games. But then how did these ordinary people get such piles of money?

Then it comes to you. They're all winning. In fact, as you walk around the green wing, you hardly can find a losing player. You know, of course, that the average house take on table games is 5%, but as you count winning and losing hands, you realize these players are getting a better break. They seem to be gaining at a rate of 60% to 40%. You start fresh and take another count. The results are the same.

A pit boss appears at your shoulder.

"Excuse me," you say, "but can this be right? The odds favor the players?"

"Yes, indeed. The odds in the green room usually run 60 to 40. It's been that way since we opened."

"But…most of the players must go away winners."

"They sure do. At those odds, we calculate that 9,999 out of 10,000 make money. At our high-stakes tables in the back, they do even better, with winners running about 20,000 to 1. It's a good thing we get so few players, or they'd break the house."

Somewhat amazed, you thank him and shake your head. There's no time to lose, you decide, but you'll need more than the few dollars you have in your pocket. You hatch a plan to gather your life savings, come back to the casino, and win the bundle you've been dreaming of.

On your way out, you glance into the red wing. The action level is much, much higher. The room is crowded and fairly roars with excitement. Can it be even better here, you wonder? Curious, you go in. Players bet multiple table positions, wave frantically for change, entreat the gods for luck. You see few green and black chips, fewer winning players. The piles of chips in front of them are dwindling with each hand. In fact, the odds are worse than normal. Again, you start to count. Although the players continue to excitedly toss in their chips, the odds appear to be maybe 60 to 40 in favor of the house. Once more, your curiosity whetted, you walk over to a pit boss and ask her the odds at these tables.

She tells you what you suspected. They are 60 to 40 in favor of the casino. Warming up to the subject, she chuckles and says, "This room coins gold for the casino, the chances are 9,999 in 10,000 rounds that we wind up winners." You don't have to be a genius to see that this is obviously not the place you want to be.

You go home and get your stash. You return to the casino with your fistful of money, excited, eager for action, all the time figuring how you'll do even better at the game. But then a strange thing happens. You walk into the red wing and start to play.

On Markets and Odds

Sounds like a pleasant dream rapidly degenerating into nightmare. Yet it happens daily in the market. Moreover, the odds in the green and red rooms are not just attention grabbers. They're very real. In the marketplace, in fact, some investments steadily make money, while others lose consistently at these identical odds. Like the casino, most people want investments that have a good chance of beating the market. Yet, despite considerable time and effort devoted to the mission, they gravitate toward investments where swarms of enthusiastic players are endangering their savings at odds similar to those in the red room.

It seems surrealistic, but it isn't. Generations of investors have passed up sure things to buy losing investments. We all know, for instance, that for safety we should invest in treasury bills and government bonds. The investment environment has changed radically in the postwar period, however, as we'll see in detail in chapter 13. Treasury bills and government bonds, gilt-edged securities for centuries, are now surefire ways to destroy your nest egg. Conversely, investments always viewed as more speculative, such as common stocks, have become outstanding vehicles to protect and enhance your capital.

Yes, all the prudent rules of saving we learned at our fathers' knees are out the window. Since the Second World War there has been a revolution every bit as violent to the old order of investing as the French Revolution was to the old order of Europe.

Revolution does not have to mean the destruction of your savings. As the Industrial Revolution shifted fortunes from the titled nobility to entrepreneurs, as the railroad revolution enriched the Vanderbilts and Goulds, as the information revolution enriched the Gateses and Jobses, so this investment revolution, if you know what causes the changing structure, can enrich you. In each of these revolutions, the odds strongly favored those who found the new road and disfavored those stuck in the same old path.

This book is about odds or probabilities in markets, and how to use them to your advantage. There are probabilities of success or failure in the marketplace as surely as in gambling, business, or warfare.

Napoleon was the greatest probability player of modern warfare. Most often outnumbered, he won by moving fast and concentrating his forces on the battlefield on the enemy's weak points. Yes, there was brilliance in his strategies, but a good part of his military genius lay in his knowledge of the odds in any situation. On the first Italian campaign, for instance, he gambled on the perilous dash through Genoese territory rather than throw his ragged, demoralized men against the fortified Alpine passes, and was able to defeat the numerically superior but divided Austrians by keeping his forces unified. While poised precariously before the gates of Vienna, however, he gave the Viennese a generous treaty rather than take a chance on being cut off from his supplies.

The story is told of Napoleon playing cards with his generals and staff to pass the time en route to Egypt with his invasion fleet. He heard one of his aides whispering in the background and asked him to speak up. The aide, fearing for his life, stammered, "I said, General, you are not playing fairly." Napoleon said, "That's true, but I always give the money back at the end of the game."

General Murat, who was to become one of his legendary Marshals, spoke up with trepidation, though he had always been fearless in battle. "General, if I may be so bold, can I ask a question?" Napoleon nodded and he continued, "If you give the money back, why then do you cheat?" Napoleon replied, "Because I want to leave nothing to chance."

"Interesting story," you might say, "but how does it apply to the marketplace?" Believe it or not, despite appearances, the market does not run on chance or luck. Like the battlefield, it runs on probabilities and odds. These control markets every bit as strongly as they do roulette, blackjack, craps, or any other game in a casino. Unlike Napoleon at cards, we don't have to cheat, though our survival does depend on staying ahead of the opposition. As this book will show you, the odds in the marketplace can be turned decisively in your favor.

What is behind the probabilities in markets? Is it a new system to divine the future, or differential equations critical to the development of physics and now used extensively in economics? Millions of dollars' worth of the best research money can buy? No. Our probabilities are not built on any of these techniques or on foreseeing the direction of markets, or on any other conventional approach. Rather they are embedded in investor behavior in the marketplace.

I know it sounds strange. "Psychology," some people might snicker, "is the last place in the world to find any sort of reliable odds." It's true all the same. Betting on well-defined patterns of investor behavior will give you higher probabilities — strongly backed by statistics — than any other method of investing in use today. These are the odds available in the green wing of my imaginary casino. But how do you arrive at them?

That is what this book will try to show you. But the last thing I want to do is ask you to take my advice or anybody else's on faith. Too many systems and faith healers already clutter the marketplace. None that I know of do what they claim — beat the market. And most cost. We will carefully look at the odds of which investment methods work and which don't, forgetting the popularity of one technique or another.

To start, we'll look at the two methods heavily favored by knowledgeable investors: the use of professional money managers and the efficient market hypothesis. The first relies on the "edge" the professional investor can give you by banking on his or her knowledge, skill, and experience to turn the odds in your favor. Do these professionals understand the new market dynamics that I have discussed briefly? Do they win big in this dramatically changed environment? To find out, let's look at the expert record.

Great Expectations

Professional investors manage large pools of money for mutual funds, pension funds, bank trust departments, money management firms, insurance companies, and similar financial institutions. The assets under their management are growing phenomenally, surpassing $14.8 trillion by the end of 1997, and expanding faster than the GDP (gross domestic product). They control over 70% of the trading and 50% of the stock holdings on the New York Stock Exchange. Their buying power staggers the imagination. By 1997 they were estimated to be buying and selling $2 trillion of stocks annually, generating $10 billion of commissions in the process. They claim the crown as the elite of their profession.

The professional money manager is belie…


Amazon.com Review
All stock-market investors embrace the motto "Buy low, sell high." Few act accordingly, however, for to do so would require that we go against the crowd, buying stocks that are out of favor and selling Wall Street's darlings. Powerful psychological forces prevent us from pursuing a contrarian investment strategy, although it consistently beats the market, according to David Dreman, a seasoned money manager and long-time columnist for Forbes magazine. One of the Street's best-known and most articulate contrarians, Dreman has updated his 1982 investment classic, Contrarian Investment Strategies, using recent research on investor psychology. His revised book combines proven techniques for selecting undervalued stocks with fresh insights on how to defy, and thereby profit from, the popular fears or enthusiasms of the moment.
Dreman pays only cursory attention to a company's business fundamentals in deciding whether to invest in it. Instead he looks for stocks trading at below-market multiples of per-share earnings, cash flow, book value, or dividend yield. Historically, Dreman claims, stocks that are cheap by any of these measures have tended to outperform the market average, although this is disputed by those who believe the stock market is efficient and therefore impossible to beat except by accident. Dreman devotes many pages to debunking their research. He offers a new refinement of his low-price strategy, which involves picking the cheapest stocks within industries, to create a diversified, contrarian portfolio.

Contrarian Investment Strategies: The Next Generation is full of practical and provocative advice, but some of its most interesting passages delve into the abstruse findings of cognitive psychology. This research has proven that we are woefully inadequate as intuitive statisticians. Interpreting data to make predictions about the probability of future events, we consistently make the same mistakes. For example, we exaggerate the likelihood that current trends will continue, even when they are historically exceptional. (Logic dictates that trends are more likely to regress toward the mean.) This fallacy explains why most Wall Street insiders were gloomiest about stocks in 1981, after six years of falling prices, just before the beginning of the greatest bull market ever. Is today's widespread optimism among investors a reason for caution? Dreman thinks so.

It seems our brains are hard-wired to underperform the market. That's why few investors can keep to a contrarian approach. Dreman recommends buying stocks when prices fall, the worse the panic the better. But that requires overriding powerful instincts.

Besides reflecting Dreman's wide reading in finance, psychology, and history, his book also displays his sometimes windy and self-important writing style. At 464 pages, the book is not a quick read. But its intellectual depth and thoroughly tested advice make many other investment books look paltry and superficial by comparison. Serious, independent investors will find it rewarding. –Barry Mitzman

From Library Journal
Manager of the Kemper-Dreman High Return Fund and chair and CEO of Dreman Value Management, Dreman analyzes contrarian investment strategies for the 1990s and into the 21st century, defining contrarian investment as involving buying and selling securities by going against the crowd and prevailing investor opinions. He emphasizes the importance of investor psychology, which he terms "the necessary link required to activate the contrarian strategies we will now examine." Additionally, Dreman describes investor overreaction as a response to events in a predictable fashion: investors "consistently overvalue the prospects of `best' investments and undervalue those of the `worst.'" He presents and discusses 41 contrarian investment rules involving such factors as stock performance, political and financial crises, volatility, and analysts' forecasts. Especially interesting are the specific case studies involving the effect on the securities markets of major crises such as the 1987 stock market "crash" and the Gulf War. Highly recommended for business collections in both public and academic libraries.?Lucy T. Heckman, St. John's Univ. Lib., Jamaica,
Copyright 1998 Reed Business Information, Inc.
Marshall Loeb editor, Columbia Journalism Review; Former Editor, Fortune magazine David Dreman has written one of those rare, original books on the market that appear every generation or so. Powerful, profound, and extremely well documented, it provides totally new strategies for investing in the 1990s and beyond.

Martin Edelston editor, Bottom Line/Personal Lots of people call themselves contrarians, but David Dreman is the real thing. His shrewd strategies put you far ahead of conventional wisdom. This new classic is easy and valuable reading for anyone interested in beating the market.

James W. Michaels Editor, Forbes magazine David Dreman shows you how to make psychology — both yours and the market's — work for you, not against you.

A. Michael Lipper Lipper Analytical Services, Inc. There are relatively few good money managers or good writers on investments. David Dreman is both. In Contrarian Investment Strategies: The Next Generation, Dreman's focus on the understanding of "risk" should free investors from the mathematical traps of so-called risk measurement. In plain language, Dreman explains that the real risk is in investments that underperform for your needs and expectations. This is a great book for all investors, laymen and professionals alike.

Sandra Ward Barron's Beating the S&P 500 consistently. A mutual-fund fantasy? A dream, perhaps. Well, in a way, yes: Dreman it is — David Dreman, chairman of Dreman Value Advisors, and his Kemper-Dreman High Return fund delivering as advertised. Better still, the best is likely yet to come.

From the Publisher
Praise for Contrarian Investment Strategies: The Next Generation
"A generation of academic research has rested on two basic premises — that markets are perfectly efficient and investors are rational. Only now are the Ivory Towers waking to what holders of dog-eared copies of David Dreman's original "Contrarian Investment Strategy" have long known: Both premises are wrong. Securities, at times, can be priced very inappropriately, and investors' actions, at almost all times, are based on powerful psychological forces, not on cold, calculated thought. Rather than assume a neat, reasoned world that doesn't actually exist, "Contrarian Investment Strategies: The Next Generation" deals with today's market realities. Not surprisingly, Dreman's conclusions are often at odds with conventional wisdom… Skip the academics and just read Dreman." — Don Phillips, President and CEO, Morningstar, Inc., April 20, 1998

"David Dreman has written one of those rare original books on the market that appears every generation or so. Powerful, profound, extremely well documented, it provides totally new strategies for investing in the 1990's and beyond." — Marshall Loeb, Former Editor, Fortune and Money magazines, February, 1998

"Lots of people call themselves contrarians. David Dreman is the real thing. This seminal work puts you far ahead of conventional wisdom, offering dynamic new money making strategies for both the average and the professional investor alike. A classic — lucid, witty and entertaining. Must reading for anyone interested in beating the market." — Martin Edelston Editor, Boardroom Reports and Bottom Line, March, 1998

"Most people like to think of themselves as contrarians… But few have earned true contrary credentials, with a contrary point of view and a winning record. Dreman is one of the few. Dreman's true contrarian colors come into play when he discusses the stock market's irrationality. In particular, his discussions of the efficient market theory and modern portfolio theory … are wonderfully scathing. Dreman's conclusion: Independent thought and research beats most popular market theories." — John Waggoner, USA Today, December 21, 1998

"There are relatively few good money managers or good writers on investments. David Dreman is both. In "Contrarian Investment Strategies: The Next Generation," Dreman's focus on the understanding of risk should free investors from the mathematical traps of so-called 'risk' measurement. In plain language, Dreman explains that the real risk is investments that underperform for your needs and expectations. This is a great book for all investors, laymen and professionals alike." — A. Michael Lipper, President, Lipper Analytical Services, February 10, 1998

"Dreman's erudition will appeal to any student of history or popular culture… Above all, [his] book peddles common-sense advice from a veteran who's given investing topics decades worth of thought." — Adam Lashinsky, Chicago Tribune, May 25, 1998

"Last week, I was as eager to listen to David Dreman when he visited to talk about his new book — "Contrarian Investment Strategies: The Next Generation" — as I was after reading "Psychology and the Stock Market" 20 years ago. Dreman is the Maharaja of the Multiples… If you want a reality foundation for investing, get yourself a copy." — Scott Burns, Dallas Morning News, May 26, 1998

"A frequently asked question has been what books would you include in an investment library…[W]e named … David Dreman's new book, "Contrarian Investment Strategies: The Next Generation"… And it's bound to capture attention and arouse controversy… The thrust of his book [is that] common [psychological] mistakes open up opportunities for others to use disciplined value strategies." — Eric T. Miller, Chief Investment Officer, Donaldson, Lufkin & Jenrette, excerpted from Portfolio Manager's Weekly, May 6 and May 13, 1998

"Contrarian Investment Strategies" provides a treasure trove of useful research findings. In his eagerness to give something back to his profession, David Dreman is an excellent role model… This book is clearly a labor of love by a man dedicated to discerning the truth amid a morass of emotionalism and cognitive error." — Martin Fridson, Financial Analysts Journal, November/December, 1998

"I have just got into David Dreman's "Contrarian Investment Strategies: The Next Generation," and I am going to take the unusual step of putting in a good word for an investment book before finishing it. Canadian-born Dreman is both a money manager who has beaten the market benchmarks and a stimulating independent thinker. This time he adds some timely input on investment psychology." — Patrick Bloomfield, The Financial Post, May 6, 1998 and May 16, 1998

"Overcoming psychological barriers is the hardest challenge when buying out-of-favour stocks. For inspiration the best book I have read is "Contrarian Investment Strategies: The Next Generation" by David Dreman. Dreman's funds have an excellent long-term record on Wall Street and his ideas can be adapted here." — Edmond Jackson, The Sunday Telegraph, January 31, 1999

"Loaded with solid advice for the average investor. How can you not like a man who dislikes forecasters, market timers, small cap stocks, complex risk analysis, bonds, bank savings, annuities and selling when the stock market declines. Is this guy tapping my phone?" — Cliff Pletschet, Oakland Tribune, July 12, 1998

"Dreman's latest book, "Contrarian Investment Strategies: The Next Generation," expands on his three decades of scrutiny of market trends. Aimed at individual investors and money managers alike, [it] is smart [and] well grounded in history." — John T. Ward, the Newark Star-Ledger, August 31, 1998

"David Dreman writes great books… "Contrarian Investment Strategies" is loaded with great stuff." — Eric Hanson, President, Hanson Investment Management Inc., The Hanson Newsletter, June, 1998

"Frequently described as the dean of Wall Street's contrarians, Dreman has managed to stay ahead of the market by straying from the investment herd. He shares [with the reader] a disciplined strategy … along with an assessment of investor psychology to make decisions." — Michael Liedtke, Contra Costa Times, May 22, 1998

"Finally an investment book that's not filled with fluff, meaningless data, and boring anecdotes. "Contrarian Investment Strategies: The Next Generation" is a Gem… Backed by well-researched data, [he] discredits traditional investment theory, including market timing, with the same tenacity that The Amazing Randy debunks the paranormal. Mr. Dreman's thesis is backed up with loads of data yet he makes the book an easy read by wrapping it with entertaining analogies and anecdotes from his illustrious career." — David Goldman, The Laughing Stock Broker.com, June 18, 1998

"Dreman details the ins, outs, ups and downs of contrarian investing. Undoubtedly, Dreman is the man to do it. Shrewd investors, he asserts, can surpass professional money managers… [His] theories rightly give one pause before jumping on the more popular bandwagons in today's markets." — Mary Scott, Research, June, 1998

"Dreman shows you how to make psychology — both yours and the market's — work for you, not against you." — James W. Michaels, Editor, Forbes Magazine, February 2, 1998

"Highly recommended for business collections in both public and academic libraries. [Dreman] emphasizes the importance of investor psychology [investor decisions] which he terms "the necessary link required to activate contrarian strategies." — Lucy T. Heckman, Library Journal, May, 1998

From The Washington Post
Dreman is the king of the contrarians…. With original research, Dreman has come up with some startling results, which he lays out in great detail in his book. I won't go through all the calculations, but he demonstrates that, when you take inflation and taxes into account over a 15-year horizon, bond returns are actually negative–while those for a diversified stock portfolio are strongly positive…. So get the book, and get the stocks.

About the Author

David Dreman (born 1936) is a noted investor, who founded and is Chairman of Dreman Value Management, an investment company. The company focuses on the assets of mutual funds, pension, foundation, and endowment funds, as well as high net-worth individuals.
Dreman has published many scholarly articles and he has written four books. Dreman also writes a column for Forbes Magazine. Dreman is on the board of directors of the Institute of Behavioral Finance, publisher of the Journal of Behavioral Finance.
Previously, Dreman was Director of New York Research for Rauscher Pierce Refsnes Securities, Senior Investment Officer with J & W Seligman, and Senior Editor with the Value Line Investment Service.
Mr. Dreman is also the co-editor of the academic journal, The Journal of Psychology and Financial Markets, a Director of the IFREE Foundation, whose founder Vernon L. Smith was awarded the Nobel Prize in Economics, and President of the Dreman Foundation.
Dreman was awarded a Doctor of Laws Degree from the University of Manitoba in 1999 and is a member of the Board of Trustees of the university.

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