Monday, July 5, 2010

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.

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