Education Segment - Some of the top contrarian investors of our time and what we can learn from them

 

David Dreman
Dreman was once described by Kiplinger's magazine as the "consummate contrarian". His Kemper-Dreman High Return Fund was one of the best performing mutual funds ever in the U.S., being no.1 versus its comparative group for ten years from 1998. Dreman is author of the books, "Contrarian Investment Strategies: The next generation", "Psychology and the stock market".Dreman's investment strategy whilst running his High Return Fund was to focus on buying stocks that were either overlooked by other investors or beaten down by the market. In Dreman's view, investors tend to overreact to market conditions and routinely either under value or over value companies depending on what sector is "hot" at the current time and also overeact to market surprises such as profits warnings. Dreman's view was that by owning stocks that were currently in favour, any negative event has a serious downside whilst positive "surprises" would have little impact. He advises going against the crowd by buying stocks that are cheap because of an overreaction or fear on the basis of key financial measures. He also believes that a major market crisis like the one that occurred during 2008 and early 2009 as an outstanding opportunity to profit - "buy during a panic, don't sell".

In Contrarian Investment Strategies, there is an analysis of he calls the "major postwar crises" e.g. Gulf War, 1979 oil crisis. Apart from the Berlin blockade, one year after these crises the market on average was up between 22.9% and 43.6%, with an average of 25%. Two years after these events, the average gain was 37.5%.

Dreman bought stocks on the basis of 4 measures: earnings, cash flow (after tax earnings, adding back depreciation and other non cash charges), book value (value of a company's stock less all liabilities and preferred shares), and yield. His company focuses on those stocks with a market capitalisation of around $2 billion, a rising earnings trend quarter on quarter, a strong current ratio of at least 2 (measures the ratio of current assets to liabilities which is a measure of a company's ability to pay its short term debts).

However a valuable lesson for potential contrarian investors is to avoid being over aggressive in a concentrated sector when the market is in a particularly volatile positon. In April 2009, Dreman was fired as manager of the $2.2 billion DWS Dreman High Return Equity Fund after the fund lost 47% of its value over the previous 12 months. He aggressively bought beaten down financial stocks, based on a belief that the widespread pessimism on the industry was overdone. Unfortunately he was proved to be very wrong in his contrarian view of these financial stocks. In 1999, Dreman was also fired after his decision to avoid internet stocks led to his funds significantly under performing over the period. After being fired, he made returns well ahead of the market in the following few years. The difference between this period and that of 2008/2009 is that Dreman avoided try to generate big speculative gains in pursuit of a more conservative and medium-term approach. 

Warren Buffett
Buffett is known as the greatest investor of all time and is one of the richest men in the world. The so called "sage of Omaha" is Chairman and CEO of Berkshire Hathaway, a company which has an average annual return to investors of 24% since the 1960's. Berkshire Hathaway was originally acquired in the 1960's and was a textile mill in Massachussets before being used a vehicle for acquisitions of other unrelated businesses. Buffett uses the same investment philosophy as Benjamin Graham in his famous book, "The Intelligent Investor". In 2008, Buffett said "It comes about from having an investment philosophy grounded in the idea that a stock is a piece of a business. If you look at it that way, there's no reason to get excited whether some analyst is recommending it or the company is splitting the shares two-for-one, or whatever. The only way to drive the extraneous thoughts out of your mind is to have a philosophy. And for us that philosophy comes from benjamin Graham and the Intelligent Investor, especially chapters 8 and 20. It's not very complicated stuff." He famously avoided the tech crash in 2000 because he said he didn't undertstand tech companies and he only invests in companies he can "get his head around". He avoids speculation and invests for the long term. He guiding principles when buying stocks are: 1) Consistent earnings growth 2) good return on equity 3) a simple business model 4) good management 5) large purchase 6) will to take an offer price. He also looks for an "enduring moat" i.e. a competitive advantage that is difficult to replicate. Buffett looks for "consumer monopolies" where a company's positon is virtually unassailable because of a strong market position or premier brand. Alternatively he may look at a company with the lowest production costs in the industry which would be difficult to replicate by a competitor.

Marc Faber

Faber, known as "Dr Doom" and for his newletter, "Gloom, Boom and Doom Report " He was a managing director at Drexel Burnham Lambert Ltd Hong Kong office from the beginning of 1978 until the firm's collapse in 1990, a company known for its dominance of junk bond trading during his tenure. The company ultimately failed after being mired in criminal and SEC investigations. In 1990, he set up his own business, Marc Faber Limited, which acts as an investment advisor concentrating on value investments with tremendous upside often based on contrarian investment philosophies. Faber is famous for advising his clients to get out of the stock market one week before the October 1987 crash, forecasting the end of the Japanese bubble in 1990 and calling the bottom of the market in March 2009.

John Neff

John Neff managed the Windsor Fund for more than 30 years which averaged a return of 13.7% during the years 1964 to 1995 when he was running the fund against a gain of 10.6% in the S&P 500. He had a similar approach to Buffett in not spending lavishly on corporate premises and buying a modest property. In his book, "John Neff on Investing" he talks about his focus on beaten down stocks with low price/earning's ratio's, that had posted new 52 week lows or had published a particularly bad piece of news. In fact Neff described himself as a "low price-earnings investor" targeting companies with a p/e 40-60% below the market average, believing that stocks with a high p/e had so much expectation built into them that they often fell at the slightest piece of bad or even expected news. On the contrary, companies with low p/e's, had the benefit that "indifferent financial performance by low p/e companies seldom exacts a penalty". Neff seperated the badly run low p/e companies by looking at earnings growth, buying companies with consistent and "reasonable" growth i.e. more than 6% but not more than 20%. He believed that firms with a very high earnings growth had too much risk. Another Key part of his approach, was to look for stocks with a good dividend payout, for this reason he focused on total return (EPS Growth plus dividend yield). Finally he would make sure the free cash flow was strong.

Neff talks about the the difficulty of deciding when to sell a stock. He says "investors fall in love with a winning stock and hold onto it too long - particulary when their contrarian stance has been vindicated". May investors fear that they will sell winners too soon and miss out on even greater gains but Neff said "Instead of groping for the last dollar, we gladly left some upside on the table. Catching market tops was not our game. This was preferable to getting caught in a subsequent downdraft, which is never a pretty picture". Neff sold stocks when there was deterioration in the stock's fundamentals (earnings growth) or it's price approached the target set when it is was bought.

Anthony Bolton
Anthony Bolton is widely regarded to be the U.K.'s most successful fund manager. Over twenty five years he delivered a market-beating annual return of 20% in his Fidelity Special Situations Fund, 7 % higher than for for the FTSE All-Share index. In his book, "Investing Against the Tide - lessons from a life running money", he talks about his contrarian style. Much of his success came from buying stocks in turnaround situations. A key element in this approach is to meet with the management and satisfying himself that they know what they're doing and can execute their plans.

Using technical indicators and charts, he attempts to establish where we a company is in its cycle and invests accordingly. Bolton's philosophy is that you have to do something different to the market in order to achieve superior returns, "if you want to outperform other people, you have got to hold something different from other people. If you want to outperform the market, as everyone expects you to do, the one thing you mustn't hold is the market itself." He focused on stocks with recovery potential, who had unrecognised growth, had a unusually low and unjustified valuation based on its earnings or had takeover potential,.