Saturday, June 26, 2010

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.

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