Q&A: DAVID N. DREMAN "THERE ARE STRATEGIES WE’VE USED FOR 25 YEARS…THEY ARE UNSHAKEABLE"

David Dreman was a contrarian investor long before it became fashionable. “I grew up to the idea that the experts weren’t right,” says Mr. Dreman, whose first mentor was his father, a commodities investor in Canada.

Going against the herd led him to make some winning moves like buying pharmaceuticals when the market was spooked by the Clinton administration’s attempts at health care reform in the early 1990s. Mr. Dreman scooped up shares of Merck & Co. and Bristol-Myers Squibb Co. at about 14 times earnings. Today, he’s unloading them at 35 times earnings.

It’s a strategy that hasn’t failed him yet. The $4.3 billion Kemper-Dreman High Return Fund is ranked the No. 1 equity income fund by Lipper Analytical Services Inc. for the three-year period ended April 16 and No. 2 over five years.

Mr. Dreman’s firm, Dreman Value Management, will be managing the fund through 2003 under a five-year contract it signed with Scudder Kemper Investments Inc. last July.

Besides managing money out of offices from Aspen, Colo., to Red Bank, N.J., to his yacht in the Caribbean, he’s busy promoting his third book — “Contrarian Investment Strategies: The Next Generation” — to be published next month.

Q What is a contrarian in your opinion?

A A contrarian value strategy uses low P/E, low price-to-cash flow, low price-to-book and high yield. All of these strategies outperform the market very easily. When we pick portfolios, we don’t have to turn over so much. Our turnover is maybe 15% per year. So we have lower transaction costs and are more tax efficient.

Q What isn’t a contrarian?

A Contrarian can mean anything. If contrarian strategies are working, everyone jumps on the bandwagon. But there are strategies we’ve used for 25 years and they are unshakeable.

Q Describe your stock-picking strategy.

A What we have found is that you don’t have to have only the cheapest stocks in the market. We can get the cheapest stocks in industries and still do better than the market over time.

Q When do you sell?

A One of the things we don’t do is pick an absolute price target. We sell stocks when they move over the market multiple.

Q You’ve done very well during this bull market. I thought that contrarians do poorly in strong bull markets and fare better in bear markets.

A We are more defensive these days. We are not in technology or the Internet. We are heavy in oils and financial stocks. We have a tobacco position. If the market goes down, history has shown that low P/E and low price-to-book outperform. We’ve been through four or five market declines. In a bad market, the worst we have done is come in at 300 basis points below the S&P average.

Q Your High Return Equity portfolio has about 35% in financial services. Why do you like the sector?

A Even with the enormous run-up in the bank stocks and financial stocks, they are still at significant discounts to the market P/E. The S&P (500 stock index) is maybe 28 times trailing earnings and the average bank stock is probably 19-20 trailing. Freddie Mac and Fannie Mae have been big holdings for us. We owned them before the 1990 bank crisis, and since then they are up 12 to 14 times. Freddie is touching the market P/E and Fannie is still at a below-market P/E, so there is still good relative value.

Q You’re 61, nearing what is traditionally considered retirement age. Do you have a succession plan?

A I’ve got people who have worked with me for as long as 16 years now. Small cap manager Jeff Schuss has been here since about 1993. Managing Director Nelson Woodard has been working with the firm in one capacity or another for 15 years. In September, we brought in John Dorfman (who had been a financial editor at the Wall Street Journal). He’s an excellent stock picker. A good investigative reporter can become an analyst. You really need the same skills.

Q Have you picked one of these people to succeed you?

A That’s going to be a few years away.

Q You are an outspoken critic of market timing. Why?

A The timers are almost always buried. If somebody had timed and thought the markets were too high at the beginning of 1995 and got out — I knew some value people who did — the market is now up 130% from where they went out.

To put it in perspective, they’d need a crash 10 times the magnitude of Black Tuesday in 1929 today to break even.

Vite

David N. Dreman, 61, chairman and chief investment officer, Dreman Value Management LLC, Red Bank, N.J.

Assets: $5.6 billion

Kemper-Dreman High Return Equity (assets $4.3 billion): year-to-date return, A shares, 9.06%; 1-year, 40.23%; 3-year, 34.65%; 5-year, 22.68%

Equity income peer group: year-to-date, 11.08%; 1-year, 39.45%; 3-year, 25.87%; 5-year, 18.11%.

S&P 500 stock index: year-to-date, 14.68%; 1-year, 47.92%; 3-year, 32.21%; 5-year, 22.70%

Data are as of April 16.

Source: Lipper Analytical Services Inc.