David Dreman is the founder, Chairman and Chief Investment Officer of Dreman Value Management, L.L.C., established in 1997. Mr. Dreman founded his first investment firm, Dreman Value Management, Inc., in 1977 and served as its President and Chairman until 1995, followed by a similar role at Dreman Value Advisors, Inc. from 1995 to 1997.Mr. Dreman’s best selling book, Contrarian Investment Strategies – The Next Generation, was published in 1998 by Simon & Schuster. His previous widely acclaimed books include Psychology and the Stock Market (1977), The New Contrarian Investment Strategy: the Psychology of Stock Market Success (1980), and The Contrarian Investment Strategy (1982). Articles discussing the success of Mr. Dreman’s investment methodologies have appeared in national publications such as Forbes, Barron’s, Institutional Investor, The Wall Street Journal, The New York Times, Newsweek, Money and Fortune.
A regular columnist for Forbes for over 29 years, he has presented before the National Bureau of Economic Research, the Society of Quantitative Analysts, the Harvard Medical School, the Cambridge Center for Behavioral Studies, the Institute of Behavioral Finance, the Association for Investment Management and Research (AIMR), the National Financial Analysts Seminar, as well as numerous other academic and professional groups. Mr. Dreman’s research findings have also been published in The Financial Analysts Journal, The Journal of Investing, and The Journal of Behavioral Finance.
Mr. Dreman is also co-editor of The Journal of Behavioral Finance, President of the Dreman Foundation, and a Director of the IFREE Foundation, whose founder Vernon Smith was awarded the Nobel Prize in Economics in 2002. Mr. Dreman was awarded a Doctor of Laws Degree from the University of Manitoba in 1999 and is a member of the Board of Trustees of the University of Manitoba.
I attended the Columbia Investment Management Conference several days ago. One of the main highlights of the Conference was a presentation by David Dreman on the financial crisis. After the presentation Mr. Dreman was kind enough to sit down and answer a few questions.
Below is our conversation:
Jacob Wolinsky: In light of the financial crisis where many value investors got burned, would you change your investment strategy at all? Specifically your approach that uses the lowest quintile of companies in terms of P/E, P/B, P/D, would you modify this approach at all? Would you focus more on balance sheets in the future, or do you view this as a once in a generation market crash and do you plan not to change your investment approach?
David Dreman: You always modify. In 2008 there was a crisis which you could not determine from the balance sheet. What the CDOs were priced at and what they could be sold at were totally different.
We changed our approaches in some ways. We should not look at companies and assume if it is losing money that it as a one time earnings loss. If you get to a period where earnings are indeterminate we should probably get out of those companies much more quickly.
We have another fund it’s a very small fund that I manage. It did not do well during the crisis, but last year it was the number one fund in value it was up over 60%. In the three years it is down about 12% so it is about 10% ahead of the market.
I tend to fine tine more on earnings. If there are loses on earnings you have to move quickly and get to the bottom of the losses if you want to hold onto the company. The rest we will keep as we have in the past.
Jacob Wolinsky: Everyone nowadays is hyping gold and China. Being the original contrarian what do you think about these asset classes?
David Dreman: There have been several studies done on gold. The best study done is by Jeremy Siegel in his book Stocks for the Long Run. Gold has done well over time much better than bonds. During inflation gold has done excellent. But if you take gold versus stocks have done much well especially since World War II. So my number one choice would be stocks. Everything people are cowering away from today I would prefer to invest in.
If we have an inflationary environment value stocks should do well over the next 4-5 years. And can I say this dirt word? Real estate. Real Estate has been hit so hard if you have a holding period of 5 years with 20-25% leverage it is a 4-1 play on the upside.
My view is once unemployment comes down and that will not happen overnight that will be a long many year process, I think we will have 10-12% inflation once unemployment comes down below 6% which could be another 4 years or so. There is no question there will be higher inflation in the future and housing with leverage will be an excellent investment.
Stocks did well in Germany when the mark went down to one billionth of its value. German Stocks went up during the 20s in terms of real purchasing terms. In Brazil the same thing. So stocks have been an inflation hedge.
If you had $100,000 in 1945 in long term bonds inflation adjusted would be worth 40,000, but 100,000 in stocks would be worth today about 3.5 million. So most investors who do not need the money today and have a 4-5 year time horizon should do very well in stocks.
Jacob Wolinsky: Altria is a large position of yours. Is this a classic contrarian pick due to investor fear over lawsuits, higher cigarette taxes and more local and Federal restrictions on Tobacco i.e. Banning smoking in certain places?
David Dreman: I like the company. It has always been a high yielder and made us an awful lot of money over time. Tobacco companies are able to keep raising their prices. And they don’t have as much legal liabilities because the Supreme Court has struck down a lot of these lawsuits.
It has about a 6.5% yield right now and that is a very strong yield. I think that is a tock that will do very well, and it is a stock that is especially good for people who need income.
Jacob Wolinsky: In General you tend to focus on larger cap stocks?
David Dreman: We actually run a few funds large cap, mid caps, small caps. We just get the lowest price stocks wherever they are.
Jacob Wolinsky: But in your book you write that you favor large cap stocks?
David Dreman: Yes in general we do prefer large caps and over time they have done very well. Some of the original statistics supporting the theory that small caps do well are based on flawed methodology. We won’t mention the professor’s name I think he is still angry at me for proving him wrong.
The statistics were from the great depression. The best year for small cap stocks according to statisticians was 1932. I got curious about that because small cap companies weren’t around then. They were really large cap companies that had fallen so much in value that they were in the lower range of market capitalization. I detail all of this in my book.
Jacob Wolinsky: You do not talk much about foreign investing in your books. With the emerging markets becoming a larger percentage of the world’s GDP each year would you recommend an investor have exposure to these countries? Are you concerned about differing accounting factors, lack of investor protection and other concerns in these countries?
David Dreman: There are many factors to be concerned about. There is a liquidity factor also to be concerned about. The Russian market was down over 80% from its peak.
There are political factors to be concerned about. There are also legal factors and corporate law is not as strong.
Compared to other countries US stocks did reasonably well in 2008.
But there are other factors here. There is another factor which remains to be seen. I believe jobs are not coming back quickly and its possible 25% of jobs will never come back. I think we will look more carefully at free trade, and we will have more fair trade. There will be more political pressure to create jobs in the United States. We can’t have a nation without any manufacturing or an auto industry. All the higher paying jobs were being shipped out of America. You have a computer engineer making $8,000 or $9,000 a year versus $100,000 in the United States. And in one way it is very good because it makes companies very efficient but on the other hand it is putting people out of jobs. I think this will be a major political factor in the next five years and probably even sooner.
That being said I will invest in foreign stocks if I find cheap ones. However would I be comfortable having 50% of my money in foreign stocks? No.