The founder and Chairman of Dreman Value Management (est. 1977) shares his views on how investors can beat the market with this book (written in 1998). In reference to the efficient market hypothesis (EMH), Dreman writes "Nobody beats the market, they say. Except for those of us who do." More on this book is availablehere. One of his earlier books (from 1982) has already been summarized here.
Chapter 12
Chapter 12
This chapter is dedicated to the topic of crisis investing. This is another form of contrarian investing which Dreman recommends, but with a few added caveats.
How will investors know the market is in crisis? The crisis, be it financial, a war or some other reason, will dominate the news headlines. Investors will sell down industries or markets by 50% or more in very short periods. Rather than discuss prices of companies in the context of their earnings power or balance sheets, there will be a selling stampede for the exits as investors are willing to sell at any price.
Dreman takes the reader through a few crises that have happened historically, and how the investor could have identified and profited from these opportunities. In particular, Dreman discusses his own actions in profiting from the meltdown of the financial and bond markets in the early 80's, and the pharmaceutical industry plunge that occurred a few years later.
Diversification is key to crisis investing. It is often difficult to tell which companies will survive, but by researching diligently, the investor can get a good idea of which group of stocks is likely to be able to outlast the downturn. By diversifying among these issues, the investor stands to profit greatly.
Emphasis should also be placed on balance sheet strength, especially a company's debt to equity ratio. The companies with strong financial positions should be able to outlast the downturns, and perhaps even profit from them.
Chapter 13
Chapter 13
Dreman compares the returns of stocks to those of bonds and T-bills over several historical periods. While stocks outperform bonds over long periods, the sheer magnitude of the relevant performance is not clear until the investor considers the effects of inflation and taxes.
Through most of the 19th and 20th centuries, inflation was benign. For example, in 1940 the dollar still had 88 cents of the purchasing power it did in 1802! But since World War II, inflation has been relatively strong; today's dollar only has 8% of the purchasing power it had in 1802!
Too much money chasing too few goods results in inflation, so why has inflation picked up over the last 70 years relative to the previous 150? Dreman argues that government deficits are a major contributor, as governments have tended to increase national debt levels to finance wars, entitlement programs, natural disasters, bail-outs and other events. Unfortunately, they don't run surpluses as much as they should when times are good. Furthermore, since WWII, wages have been made sticky on the way down. As such, prices rise easily but they do not come down when they should, from a supply/demand point of view.
Whatever the reasons, as long as inflation continues going forward, stocks should outperform bonds and T-Bills by an even larger margin. When the price level for goods changes, businesses can earn revenues at the higher price level, but bond holders get left receiving lower dollars amounts.
Conventional wisdom suggests diversification between stocks, bonds and T-bills, but based on the evidence presented in this chapter, Dreman argues that portfolios meant to last more than four or five years should be squarely invested in stocks. Dreman might be sued if he placed 90% of the assets of a pension plan (with a decades-long time horizon) in stocks, because it goes against the prevalent wisdom of the day, but due to inflation he believes this to be a position which will clearly outperform what are considered the more "conservative" allocations.
Chapter 14
Chapter 14
This chapter discusses the topic of risk. Currently, the finance industry defines an investment's risk by its price volatility. The theory suggests that investors require compensation for taking on volatility, and therefore securities with higher volatilities have higher returns. Dreman takes issue with this simplistic definition.
First, he points to evidence that suggests volatility and returns are not correlated. This puts a hole in the theory that investors are indeed compensated for taking on more volatility.
Dreman also argues that semi-variance (as opposed to standard deviation) is a better measure of volatility (though still not perfect). After all, nobody would consider a stock that rises more than the market (i.e. that is volatile on the way up) to be risky, so only downside volatility should be considered.
But finally, volatility is only one of the risks investors face. The risks described in the previous chapter, taxes and inflation, should also be considered. The fact that T-Bills (the "risk-free asset" according to the finance industry) have actually lost money over time once inflation and taxes are taken into account suggests volatility does not adequately represent the risks facing investors.
Saj Karsan
http://www.barelkarsan.com
Saj Karsan
http://www.barelkarsan.com
