David Dreman’s Top Stock Picks

David Dreman founded Dreman Value Management in 1977. He has serves as the president and chairman of the company since then. Dreman has also published a large number of scholarly articles. He writes a column for Forbes Magazine and he has written four books. Dreman discussed contrarian investment strategies in most of these books. Dreman is also the co-editor of Journal of Psychology and Financial Markets. He is on the Board of Directors of the Institute of Behavioral Finance, an organization that publishes Journal of Behavioral Finance.

Anadarko Petroleum Corporation (NYSE:APC)

Dreman recently disclosed the latest 13F holdings of his fund. Let’s take a closer look at the stocks that Dreman is most bullish about and decide whether it makes sense for investors to imitate these stock picks.

Anadarko Petroleum Corp (APC): APC is the largest position in Dreman’s portfolio. Dreman boosted his APC stakes by 2% over the fourth quarter. As of December 31, 2011, his fund had $52 million invested in this position. APC is quite popular among hedge funds tracked by us. There were 48 hedge funds with APC positions at the end of the third quarter. For example, John Paulson was the most bullish hedge fund manager about APC. Paulson & Co had $731 million invested in APC at the end of 2011. Ken Fisher and Ric Dillon were also in favor of APC.

However, we are afraid that APC is exposed to high risks. The exploration and production industry is cyclical and capital intensive. In order to succeed in this highly competitive industry, APC employs aggressive financing strategies. Its total-debt-to-equity ratio is 0.84 and its long-term debt-to-equity ratio is 0.83. It also looks a bit overpriced compared with its peers. APC has a forward P/E ratio of 18.71 and its EPS is expected to grow at an average of 13.83% per year in the next five years. This indicates that APC’s P/E ratio for 2014 is about 14.4. The main competitors of APC include ConocoPhillips (COP) and Exxon Mobil Corporation (XOM). COP’s 2014 P/E ratio is 7.4 and XOM’s is 8.2, both lower than that of APC. Although APC has higher growth rates, the price premium investors have to pay for that marginal growth is excessive. We prefer COP over APC. COP is also a good option for defensive investors who want to protect themselves from inflation. It has a decent dividend yield of 3.63%, versus 0.41% for APC.

SPX Corp (SPW): SPW is also a large position in Dreman’s portfolio. Dreman increased his position in SPW by 4% over the fourth quarter of 2011. At the end of last year, Dreman had $41 million invested in this stock. There were 15 hedge funds reported to own SPW in their 13F portfolios at the end of September. For example, Cliff Asness’ AQR Capital Management had $5 million invested in SPW. Jeffrey Vinik’s Vinik Asset Management also had $1.8 million invested in SPW.

We like SPW. In late January, Robert Bosch GmbH, the biggest auto-parts supplier in the world, announced that it would purchase the vehicle-servicing business of SPW for $1.15 billion. SPW has strong cash flows and growing earnings. It seems a bit risky though. It is faced with the severe competition in the industry. It is also exposed to the risk of the fluctuations of exchange rates and prices of raw materials. It is also less attractive compared with it major competitor, Emerson Electric Co (EMR). SPW has a forward P/E ratio of 15.25 and its EPS is expected to grow at an average of 15.65% over the next five years. Hence, its P/E ratio for 2014 is 11.4, versus 10.2 for EMR.

A few other large positions in Dreman’s portfolio include Allied World Assurance (AWH), Brinker International Inc (EAT), and Fulton Financial Corp (FULT). The main competitor of AWH is Endurance Specialty Holdings Ltd (ENH) and ACE Limited (ACE). Both ENH and ACE have lower forward P/E ratios than AWH and have higher growth rates as well. FULT also looks less attractive than PNC. PNC has a forward P/E ratio of 8.97, versus 10.84 for FULT. Though FULT is expected to grow at 10%, versus 7.57% for PNC, we do not think the growth rate is high enough to compensate the price premium. Similarly, EAT is also trading at higher multiples compared with its main competitor Darden Restaurants Inc (DRI).

It seems that the top stock picks of Dreman are a bit overvalued compared with their peers. We think investors should research carefully before investing in these stocks.

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