Invest like the masters: David Dreman

Invest like the masters: David Dreman

We've plumbed the minds of four great stock pickers to find your smartest investments.
Warren Buffett David Dreman Peter Lynch James O'Shaughnessy

David Dreman

This expatriate Canadian wrote the book — literally — on contrarian investing. His key finding? You can achieve great results by choosing cheap stocks that the market hates.

After graduating from the University of Manitoba in the 1950s David Dreman got his start as an analyst at his father's Winnipeg-based commodities trading firm. But Wall Street beckoned and he soon moved stateside where he has run a money management firm in Jersey City, N.J., for decades.

Dreman is perhaps best known as an author. His Contrarian Investment Strategies: The Next Generation deserves a spot on every investor's bookshelf. But he's no slouch when it comes to putting his book learning to the test and beating the market. His firm's large-cap value composite has bested the S&P 500 index by an average of 3.9 percentage points annually over the last 10 years, before fees. His small-cap value composite beat the Russell 2000 by 6.6 percentage points over the same period.

Dreman looks for stocks with low price-to-earnings ratios (P/E). These stocks are typically out of favor with investors for one reason or another. But often that's because investors have overreacted to bad news. As a group, low P/E stocks have a tendency to bounce back and perform well. In fact, Dreman calculates that U.S. stocks with the lowest 20% of P/E ratios provided average annual returns of 16.8% from 1920 to 2004, beating the market by four percentage points.

You might think that people would look at those figures and be lining up to buy low P/E stocks. The reality, though, is that investing in these firms requires courage. A good example is Dreman's investment in Altria, the cigarette company formerly known as Philip Morris. Altria has been a phenomenal performer over the long term, but it's been pummeled in recent years by tobacco-related litigation. You have to be confident in your judgment to buy a stock like Altria in the face of such overwhelming uncertainty.

Dreman's focus is on the U.S. market, but we decided to apply his methods closer to home and look for large Canadian stocks that he might like. We started with companies that earned at least $250 million from continuing operations over the last year. We then focused on stocks with the lowest positive P/E ratios. Dreman also looks for financial stability, so we required each stock to have less debt than shareholder equity as well as some revenue growth over the last three years. These criteria produced the list of 10 stocks shown in Dreman's value list. In addition to each stock's P/E and debt-to-equity ratio, we also show its dividend yield. After all, it's nice to be paid to wait for better times.

We think that low-P/E stocks will continue to earn more than their higher P/E brethren over the long haul— but such a happy result is not going to happen every year. You only have to go back to the Internet bubble to spot a period when Dreman's stocks trailed. On the other hand, low-P/E stocks usually shine during market downturns. So if you have a gloomy view of what lies ahead, you might find these stocks very much to your taste.

Dreman's value list


CompanyIndustry
Price P/E Debt/Equity Dividend Yield

EnCanaOil and gas
$52.56 6.1 0.42 0.89%
IPSCOSteel
$96.55 6.6 0.18 0.84%
E-L FinancialInsurance
$600.00 6.9 0.00 0.08%
Teck ComincoMining
$71.31 7.4 0.45 2.85%
Gerdau AmeristeelSteel
$10.31 7.7 0.34 0.90%
ING CanadaInsurance
$55.14 9.3 0.05 1.83%
Empire CompanyFood stores
$40.98 9.7 0.47 1.50%
CP RailwayTransportation
$55.23 10.6 0.68 1.38%
TD BankBanks
$66.80 10.8 0.56 2.91%
Talisman EnergyOil and gas
$18.57 11.1 0.74 0.80%


Source: globeinvestor.com, Sept. 28, 2006

http://www.canadianbusiness.com/my_money/investing/article.jsp?content=20061128_104112_4584