Friday 1 March 2013

Contrarian rules

In the Contrarian Investment Strategies: The Next Generation by David Dreman there were a set of rules that I wrote down. To understand these rules one really must read the very excellent book which I highly recommend. Especially one should read it after The Intelligent Investor by Benjamin Graham because then you will receive more figures, values and examples to what Mr. Graham was talking about.

Contrarian Rules according to David Dreman:
  1. Do not use market timing or technical analysis. These techniques can only cost you money.
  2. Respect the difficulty of working with mass information. Few of us can use it successfully. In depth information does equalise in depth profit.
  3. Do not make investment based on correlations. All correlations on the market, illusions or not, will soon shift and change.
  4. Tread careful with current investment methods. our limitation in processing information prevents the successful use of them.
  5. There are no highly predictable industries in which you can trust the market forecasts. Relying on these estimates will lead to trouble.
  6. Analysts forecasts are usually optimistic. Make the appropriate downward adjustment to your earnings estimate.
  7. Most current security analysis require a precision in analysts estimates that are impossible. Avoid methods that demand this accuracy.
  8. It is impossible in a dynamic world to forecast the future based on the past.
  9. Be realistic about downside of an investment. Expect the worst to be worse than your estimates.
  10. Take advantage of analyst forecast error and invest in stocks out of favour.
  11. Positive and negative surprises affects favoured and un favoured stocks very differently.
  12. (A) Surprises as a group improves out of favour stocks and impairs favoured stocks. (B) Positive surprise has a major effect on out of favour stocks and limited on favoured stocks. (C) Negative surprise have little impact on out of favoured stocks and a major stock value impact on favoured stocks. (D) The effect of an earnings surprise continues for a longer period.
  13. Favoured stocks under perform the market while an out of favour stocks out perform the market but the reappraisal happens slowly.
  14. Buy solid companies, currently out of favour of the market. measured by the price/earnings, price/cash flow, price/book value or by their high yields.
  15. Don´t speculate on highly priced concept stock. Blue chip stock can be profitable for everyone.
  16. Trade as little as possible. Keep stocks for years!
  17. Buy only contrarian stocks based on their superior performance.
  18. Invest in 20 to 30 stocks equally. Diversified in 15 industries.
  19. Buy only large or medium sized companies that are traded on the stock exchange.
  20. Buy the least expensive stock within one industry based on the four factors.
  21. Sell a stock when its P/E is close to the P/E of the total market.
  22. When investing consider what can be important for the stock in the future.
  23. Don´t believe short term numbers from brokers and analysts.
  24. Look into a companies prior ability of profit and loss.
  25. Don´t be seduced by a current high value deviating from the base value. Long term returns will be re-established both going down as well as up.
  26. Don´t expect your strategy to work directly. Give it time to start working.
  27. The push towards average return is fundamental for a market.
  28. It is safer to project an over reaction of speculators in comparison to the companies themselves.
  29. Financial and political crisis leads speculators to sell stocks. This is the moment to buy!
  30. In a crisis carefully evaluate the reasons for the lowered stock value. In most cases it will be based on nothing.
  31. (A) Diversify extensively. No matter how cheap a group looks you can always get a clinker. (B) Use the lifelines. In a crisis they work even better and will give you good opportunities.
  32. Volatility is not risk. Never take advice which are based on volatility.
  33. Avoid small fast-track mutual funds. They usually ends with a cliff!
  34. A given in markets is that perception change over time.

Small Cap Investing according to David Dreman:
  1. Buy companies with strong finance. Usually 40% of capital.
  2. Buy companies with increasing dividend and above average market yield.
  3. Pick companies with above average earnings growth rate.
  4. Diversify widely. Twice as many small cap as large cap stocks.
  5. Be patient. Many years nothing happens but when it happens it goes fast and high.
  6. Don´t trade thin issues with large spreads unless you know you have a winner.
  7. Consider not only commission fees but also bid/ask spread to see your total costs.

Indicators for companies according to David Dreman:

  1. A strong financial position .
  2. Many favourable operations and ratios as possible.
  3. A higher earnings growth than the market.
  4. Be conservative with earnings estimates.
  5. An above average dividend yield which can be sustained.

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