The idea in one minute
Investors overreact. They pay too much for exciting companies and sell unloved ones for far less than they are worth. Over time, both groups drift back towards normal, and the unloved ones have more room to rise.
Dreman's strategy is to buy from the unloved group, measured simply by low prices relative to profits, cash flow, book value or dividends. But cheap alone isn't enough: a company must also be strong enough to survive until the market changes its mind. That second half is what separates contrarian investing from buying whatever has fallen.
At ValuJack the TWO card carries the story of the phoenix: unloved, cheap, and strong enough to rise again.
Where it comes from
David Dreman founded Dreman Value Management and wrote a long-running column for Forbes. He was among the first to argue, from the psychology of investors, that out-of-favour stocks beat favourites. His books include Contrarian Investment Strategy (1979), Contrarian Investment Strategies: The Next Generation (1998) and Contrarian Investment Strategies: The Psychological Edge (2012).
Dreman's rules
1. Cheap on at least two of four measures
From mid-sized and large companies (in his US work, the largest 1,500), take those in the cheapest 20% of the market on at least two of:
- price to earnings
- price to cash flow
- price to book value
- price to dividend
Requiring two measures, not one, protects against a single misleading number.
2. Financially strong
- A strong balance sheet: plenty of current assets against short-term debts (he used a current ratio of 2 or more) and little long-term debt.
- Good profitability: a return on equity in the top third of companies, and pre-tax margins of at least 8%.
- A dividend yield above the market's, with room for it to grow.
3. Patience, and a clear exit
Dreman expected a contrarian holding to take two or three years to work. He sold when the stock's valuation had climbed back to the market average: once it is no longer unloved, the edge has gone.
What's not in the rules. There is no "the share price has fallen 20%" test. Being cheap on the numbers is the signal. A falling price on its own says nothing about whether a company is cheap, and research shows that over months, rather than years, falling stocks tend to keep falling.
What the evidence shows
- Value against glamour. Lakonishok, Shleifer and Vishny (1994) found that cheap "value" stocks beat expensive "glamour" stocks by about 10 to 11 points a year in raw terms, and roughly 8 to 9 points after adjusting for company size. Price to cash flow was among the strongest single measures.
- Losers bounce back, slowly. De Bondt and Thaler (1985) showed that stocks that had done worst over the previous three to five years went on to beat the previous winners.
- But not over months. Over 3 to 12 months the pattern runs the other way: recent losers tend to keep losing (Jegadeesh and Titman, 1993). Timing matters.
- The honest counterweight. Validea's mechanical model of Dreman's rules has returned about 6.9% a year since 2003, against 9.2% for the S&P 500. Value investing in general had a long, painful stretch after 2007, and contrarian strategies need the patience Dreman describes.
Value traps
The classic contrarian mistake is the cyclical company at the top of its cycle. When oil, metal or shipping prices are high, these companies earn record profits and look extremely cheap on P/E. That cheapness is an illusion: the profits are about to fall.
Dreman's financial-strength rules help, but the main defence is to judge earnings over a whole cycle rather than at its peak.
Common mistakes
- Buying because the price fell. That is catching a falling knife, not contrarian investing.
- Relying on one cheap ratio. One number can be distorted by a one-off; Dreman asked for two.
- Skipping the balance sheet. A cheap company that can't survive a bad year isn't a bargain.
- Running out of patience. The evidence is measured in years, not weeks.
How ValuJack applies it
Cheap on two of Dreman's measures. Every TWO company is among the cheapest companies on both price to earnings and price to free cash flow, the two measures with the strongest record in the research.
Financial strength, measured on cash. Instead of the current ratio we require modest debt, debt that is small compared with cash earnings, and positive free cash flow. These ask the same question: can it survive until the market changes its mind?
Profitable and well run. Floors on return on equity and on operating margin, in the spirit of Dreman's quality rules.
A dividend, covered by earnings. Like Dreman, TWO wants a company that pays its shareholders, with the dividend comfortably covered by profit.
Mid-sized and larger companies, worldwide. Dreman's 1,500 largest US companies become companies of a solid size in the markets our model covers. Banks and insurers are excluded because our survival tests don't fit their accounts.
Turned up from the low. Instead of buying a stock still in free fall, we want the price clearly above its one-year low. The card’s Bottom Reached score is set from the latest prices when the card is dealt: full marks need a clear bounce off the low and a price back above its 50-day average, and a fresh one-year low in the last month scores zero. It replaces the old "fallen and bouncing" rule, which had no research behind it.
Cyclicals valued over the whole cycle. Our fair value model uses ten-year average earnings for cyclical companies, so a peak-profit P/E doesn't make a TWO card look cheaper than it is.
The same final steps for every card
Whatever the strategy, a company only becomes a card after three more steps. Our own model estimates a fair value from the company's reported earnings, and only companies priced below it (or, for the two momentum and growth cards, not far above it) can be dealt. The Edge Check, described below, then reads the latest reports, filings and news for what the numbers can't show. Finally the company must be tradable at major European online brokers. The full process is on the methodology page, and every card ever dealt stays on the card history.
The Edge Check: what the screen can't see
Every original strategy leaves something to judgement that no screen can measure. The Edge Check is ValuJack's answer: before a card is dealt, an AI research agent reads the company's latest reports, official filings and news, and asks the one question that matters most for this strategy.
The TWO question: Is the bad news temporary or permanent?
Dreman's whole bet is that the market has overreacted. That only pays if the bad news passes. So the Edge Check starts by naming what the market fears, then looks for evidence either way.
Counts in favour
- The cause is cyclical or industry-wide, and the balance sheet can wait it out
- A fix already showing in the latest report
- The share price fall has stopped
Counts against
- The cause looks permanent: a product being replaced, a lost licence, a shrinking market
- New financing needed within a year
- A fresh one-year low in recent weeks
Checked for every card
- Insider trades: are the company's own managers buying or selling shares with their own money? Awards, option exercises and routine trades are ignored.
- Short sellers: are professional investors betting against the company, and is that bet growing?
- Report wording: has anything changed since last year in the risks, targets, dividend policy, accounting rules or the auditor's report?
- Customers, suppliers and peers: what have they said about demand since the company's own latest report?
- Management's record: have they met their own targets, and have the finance chief or the auditor left unexpectedly?
- The latest report: a clear beat or miss, and has guidance been raised or cut?
What stops a card outright
A profit warning, a takeover bid, a trading suspension, profits not backed by cash, doubt about the company's future or a qualified audit opinion, restated accounts, a large new share issue, a regulator investigating the accounts, or an unanswered fraud allegation from short sellers.
Argue the opposite
Before any verdict, the agent writes down the three strongest reasons this card could fail within the strategy's time frame, and looks for evidence on each. A reason that is confirmed counts against the company, or stops it.
How it changes the cards
Every trading day the best-ranked companies in each tier are checked. A stop removes a company; the other signals move companies up or down the order, and the best-placed company that passes is dealt. A company due to report within the next week usually waits until after its report. Open a card's details to see its Edge Check: the question, a short answer, up to three signals marked ✓ or △, what would break the case, and the date it was checked.
Every point needs a source and a date: the company's own reports, official registers of insider trades and short positions, and exchange news. Forums, social media and analysts' price targets never count, and a source that can't be reached counts as no signal, not as good news. The Edge Check never changes the fair value or the star rating, and never says buy or sell. It is research done by an AI agent under fixed rules, live since 28 October 2026; it can miss things or be wrong.
Questions people ask
What is a contrarian stock?
A company the market has given up on, priced low relative to its profits, cash flow, assets or dividends, but still financially sound.
What is the difference between contrarian investing and buying the dip?
Buying the dip means buying because the price fell. Contrarian investing means buying because the company is cheap on its numbers and strong enough to recover, whatever the recent price move.
How long does a contrarian investment take to work?
Dreman expected two to three years, and the research on recovering losers covers three to five.
Sources
- Dreman, D. (1979; 1998; 2012). Contrarian Investment Strategy and its later editions.
- Lakonishok, J., Shleifer, A. & Vishny, R. (1994). Contrarian investment, extrapolation, and risk. NBER working paper 4360.
- Stingy Investor: Dreman's low-P/E results, 1970–1996
- Forbes / John Reese: A contrarian investment strategy built for the long run
- Validea: David Dreman contrarian investor model
- Old School Value: David Dreman's rules
- Alpha Architect: De Bondt and Thaler and long-term return reversal
- Jegadeesh, N. & Titman, S. (1993). Returns to buying winners and selling losers. Journal of Finance 48.
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