"I rather fancy it's Shakespeare who says that it's always just when a fellow is feeling particularly braced with things in general that Fate sneaks up behind him with the bit of lead piping." P.G. Wodehouse in Jeeves and the Unbidden Guest

Welcome to Bookworm, my weekly column where I share insights from investing books and letters that I find interesting or useful. If you think you are hallucinating, don’t worry. Today’s insight doesn’t come from P.G. Wodehouse’s Jeeves series. It comes from David Dreman’s Contrarian Investment Strategies.

Dreman aimed to take advantage of investors’ natural tendency to overshoot with their optimism and pessimism towards different companies. In practice, this meant avoiding shares where sky-high expectations were priced in and buying into situations where investors could hardly be more miserable.

I’ve covered Dreman’s method before. But today we’re going to dig a little more into why he thinks his way of investing works. More specifically, we will look at what Dreman calls “trigger events” and “reinforcing events”.

As I write this in early February 2025, just days after DeepSeek caused a meltdown in several AI-related shares, I can’t help but think it’s rather timely.

Trigger and reinforcing events

Dreman didn’t buy hated stocks purely for the thrill of being a contrarian. His real motive was perhaps summed up best in the eleventh rule of contrarian investing that he lays out in the book:

Rule 11: Positive and negative surprises affect “best” and “worst” stocks in a diametrically opposite manner

What Dreman means here is that the best-loved stocks in a market will respond in a lukewarm fashion to good news and incredibly poorly to any hint of bad news. Meanwhile, the most hated “worst” stocks often shrug off bad news and pop higher on any news that isn’t absolutely dreadful.

Dreman would refer to a piece of good news for a loved stock (or a piece of bad news for a hated stock) as a reinforcing event. This is any news supporting the current narrative. The recent share price trend may continue but unless the news is truly surprising in its nature or magnitude, it won’t move massively.

Trigger events, on the other hand, are where Dreman sees the biggest potential for major moves. Trigger events violate the narrative, introducing an element of doubt to whatever is pinning up the stock’s hated or beloved status. As Dreman puts it, “investors take off their dark or rose-coloured glasses”.

Nvidia’s trigger event

The recent pullback in Nvidia (NAS: NVDA) could be put down to a trigger event.

The trigger in this case being DeepSeek’s claims about how much less hardware investment was needed to develop its R1 AI model, and what this might mean for how many Nvidia GPUs are needed to fuel the so-called AI revolution.

How things will actually play out is anybody’s guess, but this development threw a spanner in the previous narrative and caused investors to take another look. Whether it does or doesn’t play out isn’t really the point, either.

The point is that sky-high valuations always heighten a stock’s sensitivity to anything but stellar news, and vice-versa.

ASX companies at opposite ends of the stick

This got me thinking about which ASX companies might currently reside at the “best” and “worst” spectrum of stocks.

On the “best” side it’s hard to look past Pro Medicus (PME), which operates in an attractive market niche and has delivered exceptional results for many years. This is reflected by PME’s sky high valuation, which reflects the market’s near certainty that this will continue.

Any dent in this narrative, or even the possibility of a dent in the narrative, could prove costly for those buying in at recent highs. As for the “most hated”, we don’t even need to leave the healthcare sector.

Ramsay Healthcare (RHC) has faced one negative reinforcing event after another. Covid restrictions hit patient volumes, input and wage inflation squeezed profits, and reimbursements from health payers haven't kept up with rising costs.

Who could reasonably expect the next piece of news to be good? At current valuations, the answer appears to be simple: nobody.

How investors can use this insight

I don’t suggest trying and trade your way around situations like this. Trigger events are hard to predict by definition. Not only in their nature, but in their timing and their impact on share prices.

Recognising the potential for current expectations and narrative to shape future returns, though, is essential. This seems especially pertinent in the current market environment, where many industries and companies appear to be valued at levels that take their continued success for granted.

Another thing to consider: of the stocks that look most likely to receive a short-term bump from a positive trigger event, how many are of a quality you’d be willing to own long-term? To accommodate for this, you would either need a well-defined sell strategy or the patience to wait a long time for higher quality contrarian opportunities.

Previously on Bookworm:

  • Legendary fundie exposes mistake in my portfolio

  • Can the Star Principle help investors find big winners?

  • This investing theory could explain an unlikely ASX winner

  • A ten minute filter for better quality investments

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