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What it argues
The New Contrarian Investment Strategy is David Dreman's argument that systematic investor overreaction to both good and bad news creates predictable, persistent mispricings in the stock market that a disciplined contrarian investor can exploit. Published in 1982 and drawing on several years of empirical research, the book predated what became behavioral finance by a decade and offered one of the first systematic, data-supported cases for a value-oriented, low-expectation investing approach.
Dreman's central finding is that stocks with low price-to-earnings ratios — the so-called "out of favor" stocks that analysts and investors have given up on — consistently outperform stocks with high P/E ratios over long time horizons. The explanation he offers is psychological rather than purely financial: investors systematically overestimate the future prospects of glamour stocks (high P/E, high expectations) and underestimate the recovery potential of fallen favorites (low P/E, low expectations). Because expectations are too extreme in both directions, the market regularly delivers positive surprises to low-expectation stocks and disappointments to high-expectation ones.
What it gets right
- 1.
Low P/E stocks have historically outperformed high P/E stocks over long time horizons, not because investors are irrational but because their rationality is systematically distorted in predictable ways.
- 2.
Investors overreact to both good and bad news, creating excess pessimism about out-of-favor stocks and excess optimism about favored ones. Mean reversion in expectations is what drives contrarian returns.
- 3.
The availability heuristic means recent dramatic events — good earnings, scandals, rapid growth — have disproportionate weight on analyst forecasts and investor sentiment.
What it covers
Who wrote it
David Dreman is an American investor and author who founded Dreman Value Management and has been a contributing editor to Forbes for decades. He is one of the earliest figures to apply psychological research to investment analysis, predating the formal development of behavioral finance by several years. His empirical work on low-P/E investing and investor overreaction was later supported by academic research from De Bondt, Thaler, and others. His other major book is Contrarian Investment Strategies: The Psychological Edge, an updated version of his research.
