Super Investor #16 in our series is David Dreman – The Contrarian Investor.
Known for his disciplined and evidence-based approach, Dreman championed contrarian investing, a strategy that encourages going against the herd to find value in undervalued or overlooked companies. With a career that spans decades, Dreman has made lasting contributions to the world of investing, particularly through his pioneering work in behavioral finance and his emphasis on systematic analysis
Who is David Dreman?
David Dreman is a renowned investor, author, and founder of Dreman Value Management. Often referred to as the “father of contrarian investing,” he popularized the idea that the best investment opportunities often arise in stocks that are out of favor with the broader market.
Dreman’s research and practical experience demonstrated that low price-to-earnings (P/E), price-to-book (P/B), and price-to-cash flow ratios are indicators of strong long-term performance. His insights were groundbreaking, especially in the 1980s and 1990s, when his contrarian philosophy delivered exceptional returns. His work on behavioral finance further solidified his reputation, shedding light on how psychological biases can lead to market inefficiencies.
Early Life and Background
Early Influences
David Dreman was born in Winnipeg, Manitoba, in 1936. He studied at the University of Manitoba, earning a degree in economics. His interest in investing was sparked early in his career, particularly by observing the irrational behavior of markets.
Dreman was heavily influenced by the works of Benjamin Graham, the father of value investing. Graham’s focus on buying undervalued companies with strong fundamentals resonated deeply with Dreman, shaping the foundation of his contrarian approach.
Professional Beginnings
Dreman began his career as a director of research at Rauscher Pierce, followed by stints at other investment firms. In 1977, he founded Dreman Value Management, where he applied and refined his contrarian strategies. His early career successes validated his belief in systematic, disciplined investing based on statistical evidence rather than market sentiment.
Investment Philosophy: How David Dreman Approaches the Market
Core Principles
Dreman’s contrarian philosophy revolves around one key idea: the market is often wrong. Emotional biases like fear and greed lead investors to overreact, creating opportunities for those willing to go against the crowd.
His core principles include:
- Seek Undervalued Stocks: Focus on stocks with low P/E, P/B, and price-to-cash flow ratios.
- Avoid the Herd: Look for opportunities in industries or sectors that are temporarily out of favor.
- Focus on Fundamentals: Prioritize companies with strong financials and stable earnings, regardless of market sentiment.
Investment Approach
1. Stock Selection Criteria:
Dreman favored large-cap companies with solid fundamentals, particularly those trading at a discount to their intrinsic value. For example, companies like Johnson & Johnson (JNJ) or Procter & Gamble (PG), which maintain strong cash flows and stable earnings, fit his criteria.
2. Research Process:
Dreman’s process was methodical, relying on decades of historical data to show that low-multiple stocks tend to outperform high-multiple stocks over the long term. He also emphasized the importance of understanding a company’s financials in depth, including its balance sheet, cash flow, and earnings quality.
3. Risk Management:
A key tenet of Dreman’s strategy was avoiding speculative or “story stocks” that lacked strong financials. His focus on undervalued, high-quality companies helped mitigate risk while maintaining long-term growth potential.
Psychology and Behavioral Finance
Dreman was one of the first investors to integrate behavioral finance into his investment philosophy. He identified how cognitive biases—such as overconfidence, panic selling, and herd mentality—led to irrational market behavior. By recognizing these biases, Dreman was able to exploit market inefficiencies and find opportunities others overlooked.
Track Record: The Wins (and Losses) That Defined David Dreman
Notable Investments
Dreman’s strategy often led him to invest in industries that others abandoned during market downturns. For example:
- During the 1987 crash, he identified undervalued opportunities in blue-chip stocks that rebounded strongly as the market recovered.
- His firm also found success in the energy and industrial sectors, where temporary pessimism often created opportunities to buy companies with strong fundamentals at discounted prices.
Performance Over Time
Under Dreman’s leadership, Dreman Value Management achieved consistent long-term returns, often outperforming major benchmarks. His disciplined adherence to statistical evidence helped him weather market volatility and avoid the pitfalls of speculative investing.
Lessons for the Everyday Investor
Key Takeaways from David Dreman
- Low Multiples Lead to High Returns: Stocks with low P/E and P/B ratios have historically outperformed their higher-multiple peers.
- Avoid Emotional Decision-Making: Stay disciplined and resist the urge to follow the herd during periods of market panic or euphoria.
- Focus on Fundamentals: Always prioritize a company’s financial health and intrinsic value over market hype.
- Patience Pays Off: Successful investing requires a long-term perspective and the ability to withstand short-term volatility.
Practical Tips
- Screen for Value: Use tools to identify stocks with low multiples and strong fundamentals.
- Do Your Research: Study a company’s financials in detail before investing, including its cash flow, debt levels, and growth prospects.
- Think Long-Term: Follow Dreman’s example by focusing on sustainable growth rather than short-term gains.
Overcoming Challenges and Criticism
Challenges Faced
Contrarian investing isn’t always easy. Dreman faced periods when his strategy underperformed, particularly during market bubbles when high-growth stocks dominated. However, his long-term focus and discipline allowed him to stay the course and ultimately succeed.
Criticism:
Some critics argue that contrarian investing can lead to value traps—stocks that remain undervalued due to fundamental weaknesses. Dreman addressed this risk by thoroughly analyzing financials and avoiding companies with structural issues.
The Legacy of David Dreman
David Dreman’s contributions to investing are profound. His work on contrarian strategies and behavioral finance has influenced countless investors and academics. His book Contrarian Investment Strategies: The Next Generation remains a must-read for those seeking to understand the principles of value and contrarian investing.
Timeless Quotes and Wisdom from David Dreman
- “Markets are not efficient. They are driven by fear and greed, and contrarian strategies exploit these inefficiencies.”
- “The best opportunities often come when everyone else is running for the exits.”
Dreman’s philosophy boils down to one central idea: Stay disciplined, think long-term, and never let emotions dictate your investment decisions.
Conclusion: The Enduring Influence of David Dreman
David Dreman’s career is a testament to the power of disciplined, evidence-based investing. His contrarian approach teaches us to seek opportunities where others see risk and to remain patient in the face of market volatility.
For individual investors, his philosophy is both inspiring and practical. By focusing on fundamentals, avoiding the herd, and thinking long-term, you can achieve consistent success in your investment journey.
Happy Investing!