Contrarian Investment Strategies - The Next Generation: Chapter 17

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 the final chapter of the book, Dreman takes one last look at the Efficient Market Hypothesis (EMH) and notes its flaws for the reader. When considering the data that is often cited to provide evidence for EMH, readers should remember that correlation is not causation. In many studies, correlation is often shown, and causation is often assumed. To demonstrate this, Dreman discusses how, throughout the last several decades, skirt hemlines and Superbowl champions have correlated well with certain stock market returns, but that no serious investor would believe in a causal relationship.

The assumption that each individual investor behaves rationally is also a huge leap. Since investors have different goals, differing amounts of knowledge, and various opinions on how to interpret all the data that is available, an assumption that all investors behave in the same way is not practical.

Moreoever, Dreman takes apart the conclusions that were reached by various studies that are often cited by EMH proponents. For example, a study showing that stocks post-split show no excess returns is often used to show that markets are efficient. But Dreman digs into the data and finds that the researchers used the date of the split to measure post-split returns rather than the date of the split's announcement, which biases the results.

Other studies that show the market reacts immediately to earnings news or merger announcements are also used as evidence to show that markets are efficient. Dreman scoffs at this, noting that all the studies show is that markets react, not that they react correctly.

But the best argument against EMH in Dreman's opinion is the fact that there are several systematic methods to beat the market (including the low P/E, low P/B methods described in previous chapters). But the scientific paradigm that is EMH is so ingrained in academia that it continues to ignore the evidence against it. Until there is a new paradigm that can better explain stock market returns, Dreman doubts EMH will be abandoned. In the interim, those who employ contrarian approaches are afforded the opportunity to generate abnormally high returns.

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.

Contrarian Investment Strategies - The Next Generation: Chapter 15

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 takes apart some common stock market beliefs. He spends the most time critiquing the "small-cap effect". It's commonly believed in the investment world that small stocks outperform large ones. Some widely cited papers have even claimed the low P/E effect (where stocks with lower P/E's tend to outperform stocks with higher P/E's) does not exist when one takes into consideration the small-cap effect.

Dreman takes apart some of these claims by examining the data and pointing out the pitfalls of several such studies. The most important point to note about some of these studies is the liquidity issue of small-caps. Dreman demonstrates that because of large bid-ask spreads and commission costs of purchasing the small-caps cited in the studies (which go back to the 1930s, when bid-ask spreads for small caps were on the order of 40% of the stock price), the returns shown by the studies are theoretical and could never have been achieved in practice. Furthermore, small-caps don't trade enough for investors to have been able to scoop up enough shares, and purchases in these small issues would have changed the prices of the stocks considerably, none of which is captured in the data.

Dreman goes on to cite a subsequent study he performed which shows the P/E effect to be very much alive, and across all sizes of stocks. After dividing the universe of stocks into quintiles by size, Dreman shows that it's the P/E effect that drives the returns of small-caps as much as it does for large caps. Buying small stocks with high (low) P/E's provides similar returns to buying large stocks with high (low) P/E's.

Dreman also confirms these results using P/B and P/CF measures, suggesting that small-caps as a group perform only marginally better than large-caps, but that they do so because of the strong returns of the beaten down stocks (as measured by their earnings, book values, or cash flows).

Finally, Dreman offers some caveats for investors interested in small-caps. One of the most important items to note is that transaction costs are not simply equivalent to commission costs. Large bid-ask spreads represent very real transaction costs that are not captured by commissions. Investors must recognize this when making purchase decisions, or they may see their supposedly higher returns eroded, much to their surprise.

Contrarian Investment Strategies - The Next Generation: Chapter 14

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.

This chapter discusses the topic of risk. Currently, the finance industry defines an investment's risk by its price volatility. The theory suggests that investors require compensation for taking on volatility, and therefore securities with higher volatilities have higher returns. Dreman takes issue with this simplistic definition.

First, he points to evidence that suggests volatility and returns are not correlated. This puts a hole in the theory that investors are indeed compensated for taking on more volatility.

Dreman also argues that semi-variance (as opposed to standard deviation) is a better measure of volatility (though still not perfect). After all, nobody would consider a stock that rises more than the market (i.e. that is volatile on the way up) to be risky, so only downside volatility should be considered.

But finally, volatility is only one of the risks investors face. The risks described in the previous chapter, taxes and inflation, should also be considered. The fact that T-Bills (the "risk-free asset" according to the finance industry) have actually lost money over time once inflation and taxes are taken into account suggests volatility does not adequately represent the risks facing investors.

Contrarian Investment Strategies - The Next Generation: Chapter 13

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.

Dreman compares the returns of stocks to those of bonds and T-bills over several historical periods. While stocks outperform bonds over long periods, the sheer magnitude of the relevant performance is not clear until the investor considers the effects of inflation and taxes.

Through most of the 19th and 20th centuries, inflation was benign. For example, in 1940 the dollar still had 88 cents of the purchasing power it did in 1802! But since World War II, inflation has been relatively strong; today's dollar only has 8% of the purchasing power it had in 1802!

Too much money chasing too few goods results in inflation, so why has inflation picked up over the last 70 years relative to the previous 150? Dreman argues that government deficits are a major contributor, as governments have tended to increase national debt levels to finance wars, entitlement programs, natural disasters, bail-outs and other events. Unfortunately, they don't run surpluses as much as they should when times are good. Furthermore, since WWII, wages have been made sticky on the way down. As such, prices rise easily but they do not come down when they should, from a supply/demand point of view.

Whatever the reasons, as long as inflation continues going forward, stocks should outperform bonds and T-Bills by an even larger margin. When the price level for goods changes, businesses can earn revenues at the higher price level, but bond holders get left receiving lower dollars amounts.

Conventional wisdom suggests diversification between stocks, bonds and T-bills, but based on the evidence presented in this chapter, Dreman argues that portfolios meant to last more than four or five years should be squarely invested in stocks. Dreman might be sued if he placed 90% of the assets of a pension plan (with a decades-long time horizon) in stocks, because it goes against the prevalent wisdom of the day, but due to inflation he believes this to be a position which will clearly outperform what are considered the more "conservative" allocations.

Contrarian Investment Strategies - The Next Generation: Chapter 12

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.

This chapter is dedicated to the topic of crisis investing. This is another form of contrarian investing which Dreman recommends, but with a few added caveats.

How will investors know the market is in crisis? The crisis, be it financial, a war or some other reason, will dominate the news headlines. Investors will sell down industries or markets by 50% or more in very short periods. Rather than discuss prices of companies in the context of their earnings power or balance sheets, there will be a selling stampede for the exits as investors are willing to sell at any price.

Dreman takes the reader through a few crises that have happened historically, and how the investor could have identified and profited from these opportunities. In particular, Dreman discusses his own actions in profiting from the meltdown of the financial and bond markets in the early 80's, and the pharmaceutical industry plunge that occurred a few years later.

Diversification is key to crisis investing. It is often difficult to tell which companies will survive, but by researching diligently, the investor can get a good idea of which group of stocks is likely to be able to outlast the downturn. By diversifying among these issues, the investor stands to profit greatly.

Emphasis should also be placed on balance sheet strength, especially a company's debt to equity ratio. The companies with strong financial positions should be able to outlast the downturns, and perhaps even profit from them.

Contrarian Investment Strategies - The Next Generation: Chapter 11

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.

Dreman's contention is that investors tend to overreact both to the positive and the negative (depending on the relative outlook towards a company or industry). He cites numerous bubbles to make his case, and also points out that the opposite of bubbles also tends to occur (situations where prices are well below where they should be).

Rather than rely on anecdotal data to make his case, however, Dreman describes a study he conducted with he believes proves that investors overreact. Once again he separated stocks into quintiles based on how cheap they were (this time by their Price to Book values). He then found that the operating performance (based on 5 factors including ROE and sales growth) over the subsequent five years of the lowest quintile group was much weaker than that of the highest quintile group. Despite this, the prices of the lowest quintile group showed remarkable gains both on an absolute basis and in comparison to the highest quintile group. As such, Dreman makes the point that while the market is able to determine which set of companies will have better operating metrics, it overvalues these companies and undervalues those which are expected to perform poorly.

Dreman ends by discussing how investors can profit off such overreactions in ways that go beyond simply following a low P/E (or low P/B or low P/CF or high dividend-yield) strategy. For one thing, junk bonds tend to show abnormally high returns over time, as default rates are over-estimated. However, Dreman suggests that investors deciding to enter this arena know what they are doing as rigorous financial analysis is required. On the other hand, Dreman argues an investor with little knowledge can likely do well by investing in junk bond mutual funds.

Earnings surprises are also a good source for finding overreactions from which the investor can profit. Often, a company missing estimates by a few million dollars (pennies per share) can see its market cap cut by billions of dollars. As traders overreact, such situations are ripe for finding bargains. Studies Dreman points to have also shown that stocks that drop the most in one period are more likely than other stocks to rise in the subsequent period, suggesting a strategy of buying beaten up stocks can also be successful.

Contrarian Investment Strategies - The Next Generation: Chapter 10

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.

Dreman discusses some of the psychological effects that cause investors to stray from investing styles that the data shows beat the markets. For one thing, investors fall victim to the representativeness heuristic that causes them to see similarities in situations which are otherwise different. For example, a particular event (e.g. a recession) may have followed a market movement of what sort, and therefore the investor will interpret a repeat of that market movement to signify that another recession is on the way. Dreman encourages the reader to look beyond superficial similarities in market occurrences to avoid falling into this trap.

Another problem that causes investors to lose their way is their over-reliance on data taken from small sample sets. Investors follow a few famous market "gurus" after they make a few correct calls, when in all likelihood, with so many people making calls, there were bound to be some correct ones. Investors should look at a money manager's track record over several years (e.g. using a budget calculator), and not be convinced of the fact that a manager has superior investor prowess on the basis of a few correct calls or a couple of strong years.

One concept that humans do not incorporate very well into their decisions is regression to the mean. Tall people tend to have children shorter than they are, and short people tend to have children who are taller than they are; this is known as regression to the mean. All to often, people get caught up in the recent market movements and assume these will occur forever. But Dreman argues that high stock returns now means lower (not higher) stock returns later, as stock returns overall will regress to the historical mean.

Contrarian Investment Strategies - The Next Generation: Chapter 9

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.

Dreman expands a bit on the low P/E strategy described in the previous chapter. His research suggests that the low P/E strategy even works (by a similar margin) within individual industries, which opens up many doors for investors who can't help but avoid unfavoured industries. As a result, Dreman argues that the investor can even participate in the most popular industries of the day, and buy the companies within that industry that trade at the lowest P/E (even if those stocks trade at premiums to the market) and still generating returns that are much stronger than that of the market!

Dreman also discusses the very difficult question of when to sell an investment. There are as many answers to this question as there are investors, Dreman argues. Furthermore, few stick to their sell targets, thanks to psychological forces. For instance, if a stock rises up through the target sell price set by the investor, he will tend to find reasons to bump up his valuation.

Dreman provides a rule for investors to follow that he highly recommends investors stick to. He advises that investors sell once the stock's valuation level has reached that of the market. For example, if the investor is following a low P/E strategy, he should simply sell when the stock is at the same P/E level of the market, and use the funds to buy a new contrarian stock.

Another difficult question to answer is when to give up on a stock that doesn't see any improvement in its valuation. Dreman advises that investors give a stock 2.5 to 3 years, or more if it's a cyclical stock (as it may take more time to recover from an economic slowdown). Other investors use different time periods, however, so the investor may need to reach his own decision on how comfortable he is with his "loser" investments. For example, value investor John Templeton will give his investments six years to come around (assuming no change in fundamentals).

Contrarian Investment Strategies - The Next Generation: Chapter 8

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.

Based on the evidence described in the previous chapters, Dreman recommends four strategies for the retail investor. He suggests investors go with a low P/E, low P/B, low P/CF or high-dividend yield approach. If investors rebalance their portfolios every year such that they include twenty to thirty large stocks within the lowest 40% of each category, they should beat the market handily. Should they be willing to rebalance their portfolios every quarter, Dreman expects them to do even better, based on the data he has collected.

In addition to the criteria set out above, Dreman checks the following five additional criteria before an issue makes it into his portfolio:

• A strong financial position (current assets vs current liabilities etc.)
• Favourable operating and financial ratios
• A higher rate of earnings growth (historically) vs S&P 500, plus the likelihood that earnings will not plummet in the future
• Earnings are estimated conservatively
• An above average dividend yield

In this chapter, Dreman also introduces GARP – growth at a reasonable price. GARP investments benefit shareholders in two ways. First, as earnings grow, so does the stock price. But investors further benefit as a result of the fact that as a company shows strong earnings growth, the stock’s P/E multiple will also expand.

Finally, Dreman discusses some actual investments he has made by applying these methods. He goes into detail on how the above ratios and criteria applied to his purchases of Galen Health, Eli Lilly, Ford, Fleet Financial and KeyCorp in the 1990s.

Contrarian Investment Strategies - The Next Generation: Chapter 7

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.

Dreman takes the reader through a multitude of studies conducted by different groups of researchers, spanning different decades, and across both bull and bear markets. The studies conclude that stocks with low Price to Book ratios, low Price to Earnings ratios, low Price to Cash Flow ratios, and high dividend yields outperform the market. Conversely, stocks with low yields and high P/B, P/E and P/CF ratios severely underperform the market. Many of these studies even accounted for the levels of systematic risk of the stocks under study, and came to the same conclusions.

In an all-encompassing study, Dreman studied the returns of a 25-year strategy (ending just before the book’s publication) involving annual switching into the quintile of the market’s lowest priced stocks. The study found that low P/E stocks returned an astonishing 19% per year (low P/B: 18.8%, low P/CF: 18%, high-yield: 16.1%) compared to the market’s return of 14.9%.

Seeing as how 1970 to 1996 was a fairly bullish period for the market, Dreman also studied price performance during bear markets, and once again cheap stocks outperformed. This time, the high-yield dividend stocks took the top honours (negative returns of 3.8% per year, versus the market’s return of negative 7.5%), but stocks with low P/E, low P/B and low P/CF ratios also outperformed the general market.

Despite all the evidence, why are contrarians and value investors a small minority of market participants? Dreman argues the problem is psychological. Investors get caught up in new ideas, and despite their better judgement (including all the evidence cited above), they can’t bring themselves to invest in companies that the market has beaten down. This makes them go for IPOs of glitzy companies like Planet Hollywood and SpyGlass at P/E ratios of 100+ times earnings instead of boring companies that have been around a while that trade with small P/E or P/B ratios.

Contrarian Investment Strategies - The Next Generation: Chapter 6

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.

Having shown that surprises in EPS estimates are large in both frequency and magnitude on the stock market, Dreman now focuses on demonstrating the effect surprises have on stocks of differing levels of value.

In a study covering US stocks from 1973 to 1996, Dreman found that stocks with EPS surprises in the lowest P/E, P/B and P/CF quintiles vastly outperformed those with EPS surprises in the highest respective quintiles.

But earnings surprises can come in two flavours: positive and negative. Therefore, Dreman subsequently studied the effects of both of these types of surprises on the most popular (high price-to-X) and the most out-of-favour (low price-to-X) stocks. The results showed that negative earnings had a huge effect on the high-flying stocks (these stocks lost 4.3% of their value in the quarter following the disappointment, and 8.9% of their value in the year that followed), but little effect on the out-of-favour stocks (these stocks lost only .7% of their value in the quarter following the disappointment, and remarkably only .1% of their value in the year that followed, meaning they actually increased in value in the nine months after the first quarter following the poor results).

On positive earnings surprises, however, the out-of-favour stocks reacted very well, showing 3.6% gains in the first quarter following the good news, and 8.1% gains in the year following the good news. The high-flyers (those in the highest P/E quintile, for example) showed only small gains (1.7% in the quarter following, and 1.2% in the year following).

Dreman argues that the data clearly shows that stocks trading at premiums to earnings or book value have high expectations built into them. When earnings are positive, these stocks gain little, as strong news was already priced in. When they are negative, however, they take big haircuts. Meanwhile, stocks trading at low multiples of earnings or book values have the worst already priced into the stock. As such, disappointing data does not affect the price much, but positive data can generate strong returns! This research suggests the type of companies investors should be buying...

Contrarian Investment Strategies - The Next Generation: Chapter 5

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.

Dreman compares research analysts to dealers at the casino. The players ask the dealers, who seem to know the game well, what to play; unfortunately, the players are still destined to lose.

Investors rely on these "dealers" for their estimates in formulating their own investment decisions. However, in a paper Dreman himself authored, Dreman showed that analysts are off in their EPS estimates by about 40% per quarter. The dramatic difference is there even after removing companies with low earnings (to avoid large percentage effects just because earnings were small on an absolute basis).

Furthermore, the effect is prevalent even across industries, from cyclical to non-cyclical alike. The trend is also getting worse, with analysts in the most recent decades actually performing worse, despite their seeming informational advantages.

Analysts also tend to be overly optimistic. EPS growth from 1982 to 1996 was about 8% per year, but analyst forecasts taken at the beginning of each year suggested predictions over this period were for 21% per year.

Other studies have confirmed these findings, noting other interesting tidbits in the process. One study found that analyst estimates would be more accurate if they simply blindly assumed a 4% rise in earnings every year for every company.

Why might this be? For one thing, analysts are overconfident in their own research. Many expect their findings to be accurate within 5%, but they are not. Despite the research suggesting analysts are not accurate, each individual analyst seems to believe he is better at predicting than he really is. Furthermore, not a lot of emphasis is placed on being accurate. Analyst pay/bonus structures are often based on how much trading brokerage the analyst brings in. This helps explain why there are so many more buys than sells. (By comparison, few brokerage commissions are brought in for “sell” recommendations.) So, it’s not about being right; instead, it’s about bringing in clients.

This helps explains why one study showed that analysts that work at firms that also have investment banks issue 25% more “buy” recommendations and 46% fewer sell recommendations than their counterparts at firms without investment banks. (Investment banking clients have been known to shun firms that make negative recommendations about their stock.)

Dreman also discusses anecdotal evidence that further suggests analysts are not paid for their accuracy but for their clients. In one example, Donald Trump once requested that an analyst be fired after he issued a sell recommendation on Trump’s company. The analyst was fired, and won a few years’ worth of salary in court as a result, shortly after Trump’s company filed for bankruptcy.

Contrarian Investment Strategies - The Next Generation: Chapter 4

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.

Dreman quotes many "experts" from military to political to corporate leaders that have made famous predictions that went terribly wrong. Experts in the stock market are no different. While people gather en masse to hear the opinion of experts, Dreman argues that this actually prevents investors from achieving superior returns. Like a bad golf swing that must be unlearned, investors must unlearn the way they currently use "experts" if they have any hope of earning superior returns.

The psychological research explaining the apparent inability of experts to forecast the future is discussed. The way humans best handle problems is in a linear fashion (e.g. Step 1 do this, Step 2 do that etc.). But more complex problems require interactive reasoning, whereby the interpretation of one input can change depending on how the other inputs are evaluated. Research suggests that humans tend to apply linear approaches to solving problems that are optimally solved interactively.

The more complex the problem (i.e. as more inputs need to be evaluated), the more this "line" of thinking can lead to poor results. But exacerbating the problem is that the more inputs that are provided, the more confident the decision-maker becomes. Studies testing respondent predictions for events that are highly uncertain show that when a decision-maker is provided with more information, his ability to predict stays flat (or rises moderately at best) but his confidence increases with every piece of new information, which can be a dangerous combination.

Dreman argues that stock research requires similar interactive thinking, and that the problems that must be solved (predicting a future stock price etc.) are complex, requiring the simultaneous evaluation of scores of data points. Despite the availability of unimaginable amounts of information, the outcome is nevertheless very difficult to predict, leading to low predictability, but overconfidence on the part of experts.

Contrarian Investment Strategies - The Next Generation: Chapter 3

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.

Despite the wide following of technical analysis (described in Chapter 2), fundamental analysis is far more popular. Fundamental analysis is considered more sophisticated, as it relies on the study of accounting, investment, business and economic issues relevant to the security in question.

But despite the fact that fundamental analysis appears based on a solid foundation, these managers still underperform the market as a group! Dreman points to a number of problems in the way most fundamental investing is done. Instead of relying on past earnings as a guide, many analysts extrapolate growth trends into the future, which Ben Graham warned can be dangerous.

Growth investors point to the returns that would have been generated by investing in particular stocks when they became available, such as Wal-Mart in the 70s and Microsoft in the 80s. But for every successful growth stock, there are several dozen that don't pan out. For example, in the 1920s, everyone knew that the automobile industry would grow for years to come. But finding the three or four survivors from the hundreds of companies attempting to compete in the space was a near-impossible task. In the same way, with thousands of companies in the internet space, determining the winners from the losers before the rest of the crowd bids up the price is also fraught with error.

Dreman also notes that fundamental analysts increasingly rely on near-term outlooks, thus abandoning one of Graham's key principles. Graham noted that stocks should be looked at as if they were interests in private businesses; when considering the worth of private businesses, book value and replacement value are considered important measures. But when a stock goes public, all of a sudden the emphasis shifts towards current and extrapolated earnings.

After producing convincing evidence that technical analysis doesn't work, academics in the 1970s now came after fundamental analysis. Based on their measures of risk, academics purported to show that fundamental analysis does not yield positive returns. Dreman will discuss the problems with these assertions later on in the book.

Contrarian Investment Strategies - The Next Generation: Chapter 2

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 takes the reader through the history of technical analysis. Technicians try to determine the future prices of stocks by looking at charts of past prices. They look at items like moving averages and head-and-shoulders patterns to help gauge future prices. They care not if profit explodes or if a plant implodes, as they believe they can determine future prices from past prices only.

Many early technicians used astrology to guide their decisions, and some made some correct calls and ended up well-followed. Eventually, however, every famous technician has run into a bad streak. (One such example is the famous Joseph Granville, who made a few correct calls in a row and became so well followed that it is believed he single-handedly moved markets.) Today's technician uses the immense power of computers to help detect the patterns for which they are looking.

Technical analysis has survived despite the evidence that suggests its use is of no help. As early as 1900, a French PhD Student (using commodity and bond price/volume data) concluded that past prices could not predict future prices. Since 1960, many academics have come to the same conclusion across a number of different asset classes and markets, with no exception. It is from this work that the idea of the Efficient Market Hypothesis came to be.

Dreman concludes by instructing the reader not to use market-timing or technical analysis, as they will only cost you money.

Contrarian Investment Strategies - The Next Generation: Chapter 1

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.

There are probabilities of success and failure in the market as surely as there are in gambling. But Dreman argues that the odds in the market can be put in your favour. This book is about how to do just that.

The professional money manager is often described as someone who should manage your money. Armed with the best team of analysts money can buy, he is expected to be able to buy low and sell high. Unfortunately, in practice this is not how it turns out. Dreman offers a slew of statistics demonstrating that the vast majority of managers under-perform their benchmarks.

As it became known several decades ago that managers could not beat the market, Efficient Market Hypothesis (EMH) emerged as a convenient explanation. Using computational power that was not previously possible, academics were able to "prove" that market prices were "correct" and that market-beating returns were not possible.

Dreman argues that this theory is built on a foundation of hot air, and likens it to the generations of scientists that believed the earth was at the centre of the universe. When situations occurred that seriously questioned the integrity of the theory (for EMH, the 1987 one-day point drop; for astronomers, the observation of planet locations inconsistent with their revolution around the earth), new parameters were added and the theory was made more complex to try to explain these phenomena.

Dreman sees the main problem with EMH is its built-in assumption that market participants behave 100% rationally. Psychology, however, affects all of our investment decisions. By understanding the behavioural traits that affect our decisions, however, investors put themselves in a position to put the odds in their favour.

Contrarian Investment Strategies - The Next Generation: Introduction

The founder and Chairman of Dreman Value Management (est. 1977) shares his views on how investors can beat the market with this book from 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.

It is 1998. As Dreman writes the book, the markets continue to rise. The way the market rises reminds him of 1929. To gauge the mood of that era, he has gone back and read newspaper clippings depicting the general sentiment before the great stock market crash that preceeded The Great Depression. Upon reflection, Dreman notes that the market euphoria of today (1998) appears to surpass that of the late 20's. He also argues that the price of stocks relative to fundamentals is higher in 1998 than it ever has been.

When he wrote his book in 1982, investors were interested in art, collectibles, precious metals and diamonds. At that time, he felt that stocks were undervalued...but investors weren't interested. Stocks went on to post massive gains in the years that followed.

There are ways to determine if the market is overvalued, Dreman argues, and this book will teach investors how. The contrarian methods Dreman describes and explains throughout the book are both of a fundamental and behavioural nature. Having a good strategy only gets investors part of the way towards making more money in the market; investors also need to understand their innate psychological tendencies that will try to prevent them from carrying out a sound strategy.

Investors overreact to events, both to the upside and to the downside. This is what provides contrarian investors with the opportunities to succeed.

The first function to the strategy Dreman will provide in the book is one based on the preservation of capital. The second function will be to capitalize on market mistakes in order to derive strong returns. Since no strategy should be followed blindly, Dreman will also spend time discussing why the strategies work. The first part of the book, however, will discuss why the widely-accepted, conventional strategies just don't work.