The Evidence for Contrarian Stock Selection — Dreman's Data

Most investment strategies are sold on stories and back-tested on short periods. David Dreman's contrarian framework is built on something rarer: decades of systematic data showing that the stocks investors hate most — lowest P/E, lowest P/B, most negative analyst sentiment — consistently outperform the stocks they love, over virtually every meaningful time period tested.

Why This Matters

David Dreman is an empiricist among contrarians. Where Marks articulates the psychology of market extremes and Templeton finds global opportunities at maximum pessimism, Dreman documents the statistical record that shows why contrarian stock selection works systematically — not just anecdotally or in exceptional circumstances. His research, conducted over decades and presented in Contrarian Investment Strategies, examines the returns of stocks sorted by valuation multiples: price-to-earnings, price-to-book, price-to-cash flow, and price-to-dividends. The finding, replicated across multiple time periods, countries, and definitions, is consistent: the cheapest decile of stocks by these measures consistently outperforms the most expensive decile. Not occasionally — persistently, with statistical significance, over holding periods of one to five or more years.

The Core Idea

The mechanism Dreman identifies is analyst expectations. Financial analysts, driven by the cognitive biases documented by Kahneman — anchoring, overconfidence, herding — systematically set expectations for popular stocks too high and for unpopular stocks too low. This creates a predictable pattern in earnings surprises. High-expectation stocks (expensive on valuation multiples, widely recommended, with high consensus earnings forecasts) face an elevated bar. When they meet expectations, prices do not move significantly — the expected performance was already priced in. When they miss expectations — as overconfidence and high bars make them more likely to do — prices fall sharply, as investors correct from excessive optimism to reality. Low-expectation stocks (cheap on valuation multiples, widely avoided, with low consensus earnings forecasts) face a very low bar. When they meet expectations, the response is muted. When they beat expectations — as Dreman's data shows they more frequently do — prices respond strongly, as investors correct from excessive pessimism to reality. This asymmetry in earnings surprise reactions creates the return differential. It is not that cheap stocks are better businesses than expensive stocks — they are often worse. It is that the expectations embedded in their prices are so low that positive surprises are frequent and have large price impacts, while negative surprises are less frequent and smaller when they occur.

David Dreman's Perspective

A Real Example

What to Read Next

The final foundational lesson explores the Risk of Being Contrarian — the personal and professional difficulties of holding positions that contradict the consensus, and the disciplines required to maintain contrarian conviction through the periods when the consensus appears to be winning.