Book Reviews, Value Investing

Book Review: Contrarian Investment Strategies: The Next Generation by David Dreman

Rating: Above average

Background: Book that I picked up to learn about the "official" contrarian strategies.


The key idea is that, buying a set of low P/E, P/CF, P/BV stocks (the study uses the top 1,500 largest companies from the Compustat database), holding it for a long period of time, will bring the greatest gains. The gains will be increased if

  1. You sell off stocks that have not performed in 2-3 years, and
  2. You sell off stocks when their P/E ratios have reached the market P/E ratio, and replace with another low P/E stock.

Appendix B of the book lists 41 rules for Contrarian Investing. A nice one is:

Rule 12

(A) Surprises, as a group, improve the performance of out-of-favor stocks, while impairing the performance of favorites.

(B) Positive surprises result in major appreciation for out-of-favor stocks, while having minimal impact on favorites.

(C) Negative surprises result in major drops in the price of favorites, while having virtually no impact on out-of-favor stocks.

(D) The effect of an earnings surprise continues for an extended period of time.

Finally, the book has a very good quote from Graham and Dodd's Security Analysis: "Extremely few companies have been able to show a high rate of uninterrupted growth for long periods of time. Remarkably few also of the large companies suffer ultimate extinction. For most, this history is one of vicissitudes, of ups and downs, with changes in their relative standing." which results in Dreman's Rule 27

The push toward an average rate of return is a fundamental principle of competitive markets

This aids in a way, while estimating the intrinsic value of the company, by helping with the tough questions of "how long will this company be earning above market returns?", and also, "what long-run rate of return should I be projecting?"


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