What Wall Street 'experts' forgot; The New Contrarian Investment Strategy, by David Dreman. New York: Random House. 343 pp. $16.95.
If David Dreman's book is widely read, it might revolutionize Wall Street. It could bring a great deal more sense to a market where hype, ignorance, rash enthusiasm, and panic often reign. It could cause consternation among those pin-striped investment managers whose style and air of self-confidence are impressive, but whose performance records are shown in this book to be poor.
In short, Mr. Dreman, managing director of Dreman, Gray & Embry, a New York-based investment management firm, has written a classic. It's the best book on the stock and bond markets in many years.
Over the last two decades academics, with the aid of computers and massive data banks, have analyzed the market more scientifically than ever before. Their findings have been reported in the financial press, but the implications for investors haven't really been digested. Mr. Dreman brings all this work together in an orderly, clear, and witty analysis. His conclusions are utterly devastating to many so-called market ''experts.''
''Market technicians'' - those who chart changes in stock price, trading volume, and other indicators to forecast future price movements - have been found by the computer experts to be worthless. Price movements, Dreman notes, follow a ''random walk'' which cannot be predicted by past price changes.
The other major school of stock market analysts - the ''fundamentalists'' - fare little better. These prognosticators study the past and current financial and market situation of a company in detail to predict earnings and prices. Yet here, too, Dreman shows the predictions have been inaccurate - to say the least. For many years, managers of pension funds and bank trust funds haven't done as well as the market averages, he shows. (Recently, equity mutual funds have been beating the market averages.)
One reason for the poor market performance of these full-time investment managers is that they drown in facts. ''In the marketplace,'' writes Dreman, ''investors are dealing not with 24 or 57 relevant interactions, but with an exponential number.'' Their price predictions fail because their earnings estimates are off, because the forecasts of economists are inexact, because the corporate executives they interview are wrong about the future, or for a thousand other reasons. In all these areas, Dreman proves his point by citing solid research.
If this isn't enough, the author makes mincemeat of the gold bugs and doomsayers. He points to the weakness of the Dow Theory and the recently popular Kondratieff wave, which posits a long-term business cycle. He tramples the commodity futures markets, where the majority of customers lose their investments while their brokers get rich. He examines the psychology of such market fads as high-tech stocks, which nearly always end in price busts.
Where does all this excellent but negative reportage leave the poor investor?
A lot wiser and less inclined to waste assets. But Dreman does more than this. He points to a hole in the academic theory of efficient markets, which maintains that no one can do better than the market averages without taking more risk. To disregard this theory is to be a ''contrarian,'' he explains - to buy stocks which are out of favor on Wall Street.
The unpopularity of a stock is shown by its low ratio of price to earnings. Yet Dreman demonstrates that unpopularity needn't mean a given stock is a bad investment. He writes, ''What had not been known until recently is that under certain conditions, experts err predictably and often.''
Analysts and investors, he argues, blow up the value of a stock beyond reason , or they shoot it down beyond common sense. Dreman shows by citing computer studies - and his own excellent investment record - that buying stocks with low price-earnings ratios is one way to beat the broad averages, such as the Standard & Poors 500. Moreover these low P/E stocks are not, on average, more risky than other stocks with higher P/E ratios. He employs some standard fundamental analysis to choose among the low P/E stocks, with hopes of avoiding those that sink into bankruptcy or some lesser financial evil.
In all, he offers an investment strategy worth considering - along with superb analysis of the stock market and its psychology.