MarketWatch recently had an interesting piece on contrarian investment strategies, highlighting the fact that many of the contrarian managers who were hit hard last year are now netting some strong bounce-back gains.
“As the market has bounced back in recent weeks, [several] contrarian-style funds, with their bargain-minded ways, have been outperforming,” writes MarketWatch’s Sam Mamudi, discussing well-known contrarian managers like David Dreman, Bill Miller, and Marty Whitman. “Dreman Contrarian Large Cap Value is up about 7% so far this year, while Third Avenue Value [Whitman’s fund] has gained around 13% and Miller’s fund is up 8% — well ahead of the Standard & Poor’s 500’s 2% rise.” And FPA Capital Fund, managed by Bob Rodriguez (who is planning a one-year sabbatical), is up 18% after a rough 2008, Mamudi notes.
In my own contrarian-type portfolios, I’m finding similar results — particularly over the past several weeks. In the past month, my two top performing strategies are my David Dreman-based “Contrarian Investor” portfolio, which is up 28.9% vs. the S&P 500’s 12.6% gain, and my Joseph Piotroski-based portfolio (which also has a contrarian bent), up 37.2% in that time. It’s not that surprising, considering that contrarian approaches thrive coming off of fear-laden periods. They pick up strong stocks that have been beaten down to unreasonably low levels due to fear or apathy — and in recent months we’ve seen as much market fear as we’ve seen in decades. Then, when fears subside and investors realize they’ve overreacted, these contrarian plays often take off.
The Piotroski and Dreman methods work in a similar way, first targeting the market’s most unloved stocks. The Dreman method does so by looking for low price/earnings, price/book, price/cash flow, and price/dividend ratios, while the Piotroski method does so by looking for high book/market ratios (which are the same as low price/book ratios). Both strategies then take the unloved stocks they find and test them across a variety of fundamental criteria, separating the outright dogs from the good stocks that have been unfairly beaten down (ususally because of apathy, ignorance, or fear). The Dreman strategy looks at factors like current ratio, return on equity, profit margins, and payout ratio, while the Piotroski strategy uses return on assets, long-term debt/assets ratio, cash flow from operations, and asset turnover.
Here’s a look at the current holdings of both my Piotroski-based and Dreman-based 10-stock portfolios. You’ll see that between them, they hold more than a half-dozen stocks that are up 50% or more since the portfolios purchased them.