Sunday, July 18, 2010

Contrarian Investment Strategies - The Next Generation: Chapter 16

The founder and Chairman of Dreman Value Management (est. 1977) shares his views on how investors can beat the market with this book (written in 1998). In reference to the efficient market hypothesis (EMH), Dreman writes "Nobody beats the market, they say. Except for those of us who do." More on this book is available here. One of his earlier books (from 1982) has already been summarized here.

In this chapter, Dreman examines the irrationality of some investor behaviour, and how that irrationality often culminates in bubbles that end up costing investors dearly. Bubbles are not just formed by sub-average investors; instead, many of the sharpest minds become so enamoured with an idea that they will behave completely irrationally.

There are four elements to a bubble according to Dreman. First, an image of instant wealth is presented. This image drives some to dream rather than think, and therefore a crowd forms around the idea.

Second, a social reality is created. Opinions become "facts". Experiments have shown that in uncertain circumstances, we rely on the opinions of others in forming our own opinions. Often, we do it without even realizing that the opinions of others are altering our own. Dreman argues that the appropriate price of a stock, or a piece of real-estate, or a tulip bulb are excellent examples of things of which we are uncertain, causing us to rely on the opinion of experts.

Third, the opinion suddenly changes. Perceptions can change quickly in the market. Opinions that harden over years can turn out of favour in just a few short weeks or months. Overconfidence is then replaced with anxiety. Prices crash.

Fourth, the pattern repeats itself. Circumstances appear different, but they are not. Things seem "different this time", but that is part of the illusion. As an example, Dreman shows how the IPO market has fluctuated several times, becoming hot at several points (resulting in circumstances where, say, Netscape can trade at 375 times its earnings shortly after its IPO), resulting in big losses for investors at the top. Yet the pattern persists.


Paul said...


Take a look at AFFM. Trading around .4 of book. Hedge fund Red Mountain Capital has a stake, although pretty small. Christopher Flowers has owns almost 50% of it. Historically profitable, but not for the past year. No analyst coverage I can see.

Jeff said...

Paul -

Looks like you forgot to subtract Goodwill. Try your book value calculation once you've looked at real assets. That's not to say that goodwill should always be excluded. But in this case, I think it's appropriate.

If you like small cap insurance, take a look at EIHI. Trades at about 60% of book, 5x EV / net income. Catalyst for dividend in that they're freeing up cash from asset sales and moving cash up to parent from subs (need reg authority for this).

Also take a look at LIM. It's a longer shot but trades at 1-2x projected EBITDA in 2011 by my back of envelope.


Paul said...


Thank you so much! I didn't even think about the goodwill. I'll take a look at the ones you mentioned, too! :)

Paul said...


I'm not sure if you'll read this, but I saw this today and thought of you.

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