Contrarian Investment Strategies: The Next Generation (2024)

David Dreman's Contrarian Investment Strategy should occupy the 3rd place in the Hall of Investment Classics, which puts it only after Graham's Intelligent Investor and Fisher's Common Stocks and Uncommon Profits. The most important value of this book is Dreman's commitment into the treacherous water of "market irrationality", which both Graham and Fisher recognized, but neither made serious attempts to explain. "Rational market", as the basic assumption the Efficient Market Hypothesis (EMH), is also the hypothesis cornerstone. Through this book, Dreman systematically demonstrated the absurdity of such an assumption, and proved that the market is everything but rational. This landed a crucial piece of theoretical support on fundamentalists analysts like Graham and Fisher, whose investment thesis lies on the mis-valuation of the market.

I tried to extract points from the book, which I believe are either unique or original (as far as the field of investment concerns). They have been grouped into 3 categories: Psychology in Group Thinking, Psychology in Statistics and Psychology in Investments. I hope such list can be used as a quick reference this great work of Dreman?€?s.

Psychology in Group Thinking:

Gustave LeBon's theory of "psychological crowd"

Crowds think, and only think, in images. To capture the crowd, this image must be extremely simple. Crowds scarcely distinguish between the subjective and the objective. Individuals in the crowd are primitive beings.

Our beliefs, values and attitudes can be thought to lie along a continuum. On the one end, there are "physical reality", which are abundantly clear and do not require other people's confirmation. On the other end, there are those lack of firm support "social reality" (like the existence of God, etc.), which requires social proof to uphold. The more vague and complex the situation is, the more we rely on other people whose intelligence we respect. This tends to comfort people, as it reduces the level uncertainty. When the dependency on physical realty is low, the dependency on social reality is bond to be high, as man, psychologically, can only take up to a certain level of uncertainty.

The "autokinetic effect" experiment on the convergence of opinion in group:

People who are liked (like bias), who have high status (authority bias), who are reputed to be competent on the judgmental task (authority bias) or who merely exude self-confidence are more effective in influencing others. The opinion of a group "converges" as the group interacts.

Nobel Laureate Herbert Simon

Human processes very small proportion of info he receives. The filtering process is NOT passive, which provides a pretty reasonable representation of the real world, but active. "We only see what we set out to see."

Humans are much worse in solving configural problem, when different aspects of the problem interact, than serial problem, when a complex problem can be broken down sequential steps. (So one should always try to transfer a complex configural problem into a serial problem before trying to solve it)

Psychology in Statistics:

Amos Tversky and Daniel Kahneman's "law of small numbers" - when too much faith has been put on too small sampling size.

When analyzing, one should try to avoid drawing conclusion bases on too small sampling size (law of small numbers), or drawing conclusion from unreliable or irrelevant "case rate" (the available info in a specific situation).

The more "case rate" is considered to be unreliable, the more one should rely on the "base rate" ---in general info statistical for the entire category.

Avoid over-reliance on non-reprehensive data (data drawn from a small sampling size or from only a short period of time)

Avoid over-reliance on unreliable or irrelevant case data

Avoid over-emphasis on abnormally high / low one time data deviated sharply from the norms, because such abnormally is bond to regress back to the mean.

Data with a higher variance are no less reliable that data with a lower variance, in determining trends / average

People count more on experience that they can remember: recent, vivid or emotionally charged.

Psychology in Investment:

The realignment of price and value is neither immediate nor consistent. (Take both time and some random walk). People prefer to see strong and immediate correlation between the price and the perceived value of a stock, as it offers an immediate explanation (reason bias) of the prevalent phenomenon, which provide comfort psychologically by reducing the level of uncertainty.

The school technical analysis views that all fundamental information about a security has already been reflected in the price.

Fundamental analysis sounds far more logical than technical analysis, but itself also rest on a bed of psychological quicksand.

Dremen's name is eponymous with successful contrarian investing and this book methodically shows why (along with the impressive records of the Kemper-Dremen funds). A modern Ben Graham, Dremen is driven by fundamentals and underlying data, an approach that oddly marks him as a contrarian investor in today's emotion-driven markets.

Contrarian Investment Strategies provides a clear synthesis of the research that backs value investing. It also packs a good dose of simple executable advice - in essence invest in low P/E, low P/CF, low P/BV and high DY stocks that have strong balance sheets and good defensible business models - nothing new here but he does a great job laying it all out alongside the research.

One of the strongest sections of the book showed how value stocks weathered negative earnings surprises and leapt at positive surprises, while growth and concept stocks hardly budged at positive earnings surprises and plummeted on misses. This is something I've noticed anecdotally, but it's pleasing to see in the research - and, of course, provides a big justification for value investing through times of turmoil. Backing up the data is a lengthy but good discussion on investor psychology (along the lines of Shiller's Irrational Exuberance) that goes through the main behavioral biases that provide opportunities for value investors. The book ends by exposing the pitfalls of IPOs, small caps and index investing.

All in all, I believe the book remains as relevant today as it was in the mid-90's, particularly as the IPO market gears up again, this time with social networking stocks. It's as good a starting point as any if you're interested in investing in stocks for the long run.

Predictable, systematic investor errors stem from psychology, notably overreaction, overconfidence and inability to process complex data. Even understanding these forces, it is hard to stay unaffected by psychological pressures. Consistently push up the prices of the best stocks and ignore the poor stocks - not being able to see any issues pushes prices up to levels that are too high. If there is total pessimism, any good news will result in prices rebounding.
Low PE, low price to book value, low price to cash flow, dividend yield.
Investors overreact to events in a predictable fashion: consistently overvalue the prospects of ‘best’ investments and undervalue those of the ‘worst’. They extrapolate positive or negative outlooks well into the future, pushing prices of favoured stocks to excessive premiums and out of favour stocks to deep discounts. After earnings of other surprises, investments previously considered to be the best underperform, while those considered to be the worst significantly outperform, as both regress towards a more average valuation. The hypothesis also states that the maximum price swing is produced by negative surprises on best stocks and positive surprises on worst. On the other hand, positive surprises on favoured stocks and negative surprises on out of favour stocks - reinforcing events - corroborate the market’s opinion of these stocks and have a lesser impact on price movement than event triggers. Finally, the overreaction hypothesis holds that even without the occurrence of an event trigger, the best and worst investments regress towards the market average.
It is not changes in underlying outlooks that appear to be the primary cause of the major price re-evaluations of best and worst stocks, rather it is the overreaction to the exciting or lacklustre prospects of companies that often results in best stocks being priced too dearly, and worst stocks much too cheaply.
The push toward an average rate of return is a fundamental principle of competitive markets.
Author prefers an eclectic approach, adding five fundamental research indicators to picking the low PE stocks: strong financial position, favourable operating and financial ratios, higher earnings growth, conservative earnings estimates, above average dividend yield.
You won’t win every hand. Remember here the advice of a world champion chess player when asked how to avoid making a bad move: “sit on your hands”.
People don’t follow these strategies because although the data supports the strategy historically, it is counterintuitive, so people assume it won’t work moving forward. It is difficult to take unpopular positions for long periods, even if they are right in the end.
Contrarian strategies succeed because investors do not know their limitations as forecasters. As long as investors believe they can pinpoint the future of favoured and out of favour stocks, you should be able to make good returns on contrarian strategies. Human nature being what it is, this edge should continue for a few years longer.
Heuristics - representativeness, availability bias, anchoring, hindsight bias,
Difficulty forecasting - more things can happen than will happen. Stock analysts and psychology’s have been shown to use configurable reasoning sparingly. Markets are complex adaptive systems - earnings forecasts depend on large numbers of underlying assumptions, many of which are rapidly changing and hard to quantify, which means their accuracy is always in doubt. Analysts have a tendency to overconfidence.
If we have more information, it doesn’t result in higher accuracy, but does increase our confidence in our conclusions.
Analysing the subsequent market action after a crisis also makes it clear that there is a definite way to react to a crisis and a very high probability that you can profit, regardless of whether the roots of the crisis are financial, monetary or political. Difficult to buy however, because the prevailing wisdom is things will get worse, and cheaper. Although gut wrenching, holding and even buying in a panic is a winning strategy. The nagging question however if whether this time is different still goes through your mind - none of us can escape the anxiety and doubt that permeates a crisis.
Four general principles of financial speculations: 1) irresistible image of instant wealth, 2) social reality, especially from experts, 3) anxiety replaces overconfidence, 4) don’t learn from our mistakes.
Progress, far from consisting in change, depends on retentiveness. That is, your financial progress cannot be secured by embracing the fashion of the moment.
Is it because they are lucky that great men become great? No, but being great they been able to master luck - Napoleon.

Read the original if you can. Written in 1978, it is remarkable how much history repeats itself. Here was another era of hatred towards corporations and volatile stock markets. There were manias and panics, include tech stock manias, in the 60s and 70s. The only difference in the 70s was the runaway inflation.

Dreman lays out a straightforward plan for making money in the stock market over a long term horizon with less risk. He debunks fad systems and even fundamental analysis. He is even handed in his disdain for all the systems - fundamental, technical, momentum and market timing. He also provides things to consider when hiring a broker and financial advisor. It's worth the read or even just a skim.

4.5 stars. Part 2 is a must read where Dreman rips efficient markets hypothesis to shreds by poring over the original research and running new studies. He presents a new paradigm for investing based on cognitive biases, which result in predictable errors and reactions. He spends much of the book advocating for value stocks (low P/E, P/CF, P/B) and presents a number of compelling studies. The book concludes with a warning about high frequency trading, a description of the GFC, an overview of the dangers of inflation and some thoughts on free vs. fair trade.

Dreman makes a good case for Low P/E, P/B, P/CF and high Yield stocks, urging buying lowest quintile stocks in each.
This 2012 update is useful because he spends time discussing the current economic conditions and offering some strategies.
Basically he states to stay away from bonds and use stocks and real estate for the inflation he expects. Not a fan of the Goldman Sachs crowd. That alone earns kudos from me.

It's a good book for newbies in the investment world or for people who are disillusioned with growth investing prospects or for retail/ passive/ hobby investors.
I expected much more from the book but it kept going on and on about low P/E, low P/BV, low P/Cash flow strategies and how they make more sense than growth investing. And then it went on about the recent 2008-09, etc crisis. It's a decent book for the library - not much else.

I liked Contrarian Investment Strategies: The Classic Edition better. Both were more for people who people individual stocks although I managed to get some useful information nonetheless

Spoiler! Buy stocks with low P/E. I guess the fact that this book was written in the 80’s and updated in the late 90’s/early 2000s means that this wasn’t as obvious as it is today. Upon completing this 400pg behemoth, in reflection, I guess I’m perplexed that low P/E multiples were ever considered “contrarian,” or that it was non-obvious to tell investors to ignore chartists and speculation and instead, look for “deep value” in temporarily out-of-favor issues.

Very very good book! Despite it being written almost 20 years ago, the strategies outlined here are still applicable. Remember to think for yourself and do not follow the crowd!

Very good book, very interesting and plenty of good ideas. The only thing I didn't like was the excessive rumble about Efficient Market theory, I'm already convinced it doesn't work!

Marvellous. Certainly amongst the best investment books I have ever read.

STATISTICS DRAG US TOWARD THE VALUE CAMP BUT OUR EMOTIONS JUST AS SURELY TUG US THE OTHER WAY.

Hindsight bias seriously impairs proper assessment of past errors and significantly limits which can be be learned from experience.

Treasury bills, supposedly the safest investment there is, have cost investors 77% of their purchasing power since 1946.

The excessive use of credit is the first of many destructive characteristics most bubbles have in common.

The Nasdaq fell 83% from 1996 to 2002.

When the enormous surge of speculative enthusiasm ends and the bubble begins to implode the crowd becomes as extreme in its panic as it was euphoric.

Graham- don't buy a stock with a PE >20x regardless of its outlook.

Recency - people think disasters are more likely because they have happened recently. The recent trend is thought to be the new permanent trend.

Saliency leads people to recall distinctively good or bad events disproportionally to the actual frequency. It is so automatic that we barely recognise we are doing it.

In 1999 and Q1 2000 the average IPO premium was 90%. This compares to 10% historically and 20% from 1994-1998. The recency and saliency of the enormous price movements resulted in investors vividly recalling the share gains these stocks provided while downplaying the considerable risks.

The average return for an IPO from 1970-1990 was 5%pa vs 10% pa for a non-IPO stock.

Recency and saliency play a big part in IPO investing. Generally supply increases at our near market highs.

Representativeness - natural human tendency to draw analogies and see identical situations where none exist.

The smaller the sample used t he more likely the findings are to be chance rather than meaningful.

Volatility takes inputs that seemed to correlate with it in the past and states that it will work again in the future.

With contrarian investing diversification is essential - 30 to 40 stocks.

When managers look at the downside, they generally describe a mildly pessimistic future, rather than the worst possible future.

Getting what you expected produces no dopamine rush. Unexpected event do and can lead to emotional behaviour - over-reactions.

Never buy a company that is losing money.

There are very few traders who want to sell puts on the market so the cost of buying is normally high.

This book is updated recently by the author, David Dreman, a pioneer on behavioral investing and a true contrarian. He used well-organized studies to argue against the Efficient Market Hypothesis and CAPM. Although EMH has been disproved by black swan events in many circ*mstances, it still has a large support base due to the lacking of a better theory. CAPM was rejected by Eugene Fama, father of EMH as early as 1992, who stated that "Beta as the sole variable in explaining returns on stocks is dead." Beta/volatility, although a good measure of the daily fluctuation of the stock or market risk, has limited explaining power on long term risk and return.

The author's extensive research supports that deep value stock with low P/E, P/BV, P/CF and High yield will outperform the market over the long run. He showed that a positive surprise has much more impact on low P/E stocks compared to high P/E stocks, while a negative surprise has much bigger impact on high P/E stocks. He also showed that compared to the initial event trigger (the surprise), a reinforcing event has limited impact to the performance. Thus continued good news has limited impact on a high flyer with high PE, but a negative surprise will hammer the stock. With this psychological factor in mind, by buying deep value stock with existing negative sentiment, an investor will have limited downside even when bad news continues but will have substantial upside gain if there is any good surprise.

Outstanding. Dreman cuts through the clutter of prevailing investment fads and delivers a solid approach to investing based on his experiences and careful statistical research. My only wish is that I had read his newl updated 2012 book, which seems to be receiving excellent reviews on Goodreads too.

Basically a book on value, buy and hold investing.

Excellent, though it fails to tell the whole story. Beware of market manipulation....

Fallacies in investments. Psychological detrimental factors that prevent one from being a successful investor. All common sense but difficult to be executed.

On Contrarian Investment Strategy

Key take away is the difference is a great investor knows when to be a contrarian & when to be a conformist whereas a less successful value investor doesn’t