Dreman on Why to Buy Bank Stocks, and How the Credit Crisis has Hurt Value Investors

Showing the contrarian bent that made him one of the most successful investors of all time, David Dreman says it’s time for investors to jump into banking stocks.

“They will come back at some point. It’s essential to the economy,” Dreman tells Q1 Publishing. “We need a banking system we’re confident in. We can’t work without a banking system. We can patch it up for a while and the government will probably take some stake in a lot of these banks they already had, but we need a banking system. So I would buy banks.”

Dreman says he wouldn’t go big on just a couple banks, however.

Instead, he recommends buying a banking index, like KBW Regional Bank Index, which investors can buy through the SPDR KBW Bank Index Fund (KBE). “That’s the way for an investor to get in and not have a lot of risks of any one bank,” Dreman says, adding that the XLF exchange-traded fund is another good option. “So you have diversification there and the bank industry is way down. But if you stay diversified … it’s a really good index, because when finances come back I think this could yield double or triple.”

Dreman says playing the financial sector “will take time and, again, you need a lot of diversification.”

Overall, the market is exceedingly cheap, Dreman adds. “All stocks are cheaper. But they’re reaching extremely cheap levels,” he says. “So, I mean there is huge upside. I think this is probably a good time to start nibbling and just buy over a period of time.”

Asked what is the biggest investor mistake he has learned from, Dreman says it involves patience. “You want to buy some stocks, but not everything right now. And you don’t want to over concentrate anything. You want to diversify pretty wisely,” he says. “The most important thing is psychological and it’s hard to follow. When markets go against you if you think you have good stocks stay with it.”

Jumping out of the market until things turn upward will likely limit your gains, according to Dreman — he says that about 43 percent of the gains come in the first 15 to 20 days after an upturn. “So you have to have some exposure to stocks to get in on the biggest part of the upturn.”

Another suggestion from Dreman: buy stock in firms that are “very self-sufficient. You’ve got to find the ones which really don’t need much credit. Because even the best, the companies that never had problems with credit are having problems now.”

General Electric is one company that Dreman thinks “will be a survivor. Over time, as the economy recovers it’s definitely a company that will come back. You really want to have cash flow and very little debt and that company certainly has both of them.”

The lack of credit is throwing a wrench into the usual value investing machine, Dreman says. “Normally, value investing is a pretty easy job because you tend to buy solid companies that are going to come out of it fine,” he says. “But what we are seeing now is that even solid companies are being hurt because they can’t raise money. So it’s something different; it’s a very serious panic.”

But, Dreman says, the crisis will surely pass. “It’s going to be painful but anybody who can hold through this crisis will be well rewarded,” he says. “I can’t say – nobody can say – whether it’s going to be 6 months, 18 months, or 24 months. But I think they are going to see the value there in many different securities. When it comes to equities, you’ll be in for a double or triple if you have good quality stocks.”

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