12 Stocks Through David Dreman's Latest Technique

by: Simon Moore, CFA

David Dreman, the highly successful value investor, recently significantly revised his book incorporating behavioral finance, his latest thoughts on the market and a new technique for selecting a contrarian portfolio. Here we review the book and determine how to implement his new technique.

The book
David Dreman published a new book this January. Dreman is a successful manager of value investment funds and uses the book to share his worldview. As a value investor he focuses on contrarian thinking, which is buying stocks that aren't popular, he explains why basic psychology and behavioral finance mean that contrarian investing has worked historically and why it will likely continue to work in future. He also attacks the Efficient Market Hypothesis, based on his own research and those of others. At times this attack feels a little more heated and self-serving than dispassionate analysis, but still it's an interesting read. Dreman mixes the secret sauce of his own investing techniques with sharing his perspective on lots of other topics from the long-term inflation rate (going higher) to free trade (not always in America's interest). If you enjoy hearing competent investors discuss their techniques in the style of Graham or Greenblatt then you'll likely find this book a useful addition to your collection.

Applying the new technique
The new technique Dreman argues for within the book is essentially buying the cheapest stock within each sector, taking this sector approach leads to a more diversified approach than just buying the cheapest stocks that will tend to skew to particular sector.

Applying this today would yield the following stocks, here I have used a minimum market cap of $10B and included ADRs to add some geographical diversification:

Sector Stock P/E
Basic Materials Vale (NYSE:VALE) (ADR) 6x
Capital Goods Northrop Grumman (NYSE:NOC) 8x
Conglomerates Tyco (NYSE:TYC) 17x
Consumer Cyclical Ford (NYSE:F) 3x
Consumer Non-Cyclical Staples (NASDAQ:SPLS) 11x
Energy BP (NYSE:BP) (ADR) 6x
Financial American International Group (NYSE:AIG) 4x
Healthcare AstraZeneca (NYSE:AZN) (ADR) 6x
Services Telefonica (NYSE:TEF) (ADR) 4x
Technology Hewlett Packard (NYSE:HPQ) 9x
Transportation CSX Corporation (NYSE:CSX) 12x
Utilities Entergy Corporation (NYSE:ETR) 9x
Source: Google Finance Stock Screener (note - Corning initially came up as a technology stock, but I excluded it because I don't believe it's truly a technology firm)

Final thoughts
Dreman's technique appears to be a reasonable way to construct a portfolio for the value oriented investor. Of course it's worth doing your own research so that you are confident enough in the companies that you don't feel the urge to sell if prices do decline. Nonetheless, we should not use sight of the fact that the reason to hold these stocks is precisely because they are unpopular and the future will not be as bad as it is projected to be (on average). The insight that sector diversification is an important part of portfolio construction is an important one. It is also dependent on how sectors are defined, Dreman talks of 26 sectors in his book, above I use the 12 sectors from the Google Finance Stock Screener

Disclosure: I am long BP, TEF.

Additional disclosure: I am likely to open a position in HPQ in 72 hours.