Steve Forbes Interview: David Dreman, Contrarian Investor, Pt. 1?

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Dreman: Well, I guess some of them are fairly new. They’re psychological. There’s some new psychology out there that really explains bubbles and crashes.

It’s called “affect.”  And what they’ve found in the research, and this is a psychological research, is the more we like something, the more we’re willing to pay.

And they found that people can pay as much as 100 times what a stock is worth. Which explains, of course, the Internet bubble and probably all bubbles. We get so caught up in ideas, even the professionals, that we tend not to look at the real value of a stock.

Forbes: So we fall in love.

Dreman: Repeatedly. And we never seem to, as a group –

Forbes: Before we get into the – what you call cognitive psychology – what were the lessons you learned from 2008? The banks took a huge hit. What did you come out with that to sharpen your contrarian philosophy, so that if something goes wrong it doesn’t have quite the devastating impact that it did, even though it may be only short-term?

Dreman: Yeah. Well, I guess the rule that if there’s a loss don’t buy it is very, very important. With financial stocks, they’re more difficult than most others to really evaluate because you don’t get good information, even when you talk to senior people at the banks. May not be deceit – they may not know themselves. Because I think some of the very major banks had no idea about how much they owned in subprime.

Forbes: Right.

Dreman: There are a lot of complexities that just don’t show in a balance sheet. You just can’t get to them. So I would probably never go as heavily as we had gone into financial stocks. Banks would be the most complex because the reporting – although legal or certainly accept by the SEC – doesn’t really go into enough detail to ferret out what really is going on.

For example, take a bank like CitiGroup. They didn’t really have a real handle on their loss at all, I think, even near the top. I think the same was probably true with some of the big investment bankers – certainly Lehman Brothers and Bear Stearns before them. The leverage was just, again, was enormous. I think normally, banks, before they got around Glass-Steagall, leverage might have been, say, ten-to-one, 12-to-one. For some of the banks, it got up to 30-to-one. And for the hedge funds, it got up to 35-to-one, 40-to-one. With that kind of leverage and really pretty poor subprime mortgages, a 2.5% drop would wipe out all of the capital. And, of course, the houses didn’t go two 2.5%, they went down 34%.

Forbes: So even today, you wouldn’t buy a Citi or a Bank of America – or just fewer shares?

Dreman: Probably fewer shares. And also, I think today I’d buy the banks that the government has almost put their stamp of approval on.

Forbes: Like Wells Fargo?

Dreman: Wells Fargo, yes. Wells Fargo and Morgan Stanley, Fleet’s another one that came up stronger than most of the U.S. bank core. Stocks of that ilk. We probably have smaller positions, but we certainly look at them here.

Forbes: That gets to what some of the companies and industries you like are. Before we get to oil and gas, which you seem to like, what are some of the other companies? You’ve written in the past about Allstate, United Technologies. What are some of the favorites on your list?

Dreman: United Technologies is a conglomerate – they don’t use that wording, “multi-divisional company.”  But it’s been very profitable over a very long period of time with Otis Elevator, jet engines, and I think they’re moving into other areas. And I think they’ve shown earnings growth of 10%, 12% a year. Even through the bad times, they still had up earnings, the bad times being the last few years.

The P/E is fairly modest on that, it was down at 14 times earnings, or something like that. So that’s the kind of stock we like. We also have a belief that a few years out, when employment – even if it’s gradual – we’ll get down to 7.5%, possibly 7% unemployment. We’ve printed $7 trillion. We’ve doubled the debt since 2008. There’s a lot of money floating out there, not only in the United States, but elsewhere. And we think that we’re going to probably face some inflation for, at most, four or five years out.

source: forbes.com

Posted in: Interview,Steve Forbes