Valuation
Mean reversion
The tendency of extreme values — margins, multiples, returns — to drift back towards long-run averages.
How it works
Competition erodes unusually high margins; capital leaves unusually unprofitable industries until conditions improve. Valuation multiples show the same pull over long periods.
It is one of the more reliable regularities in finance and one of the least useful for timing, because the drift can take many years and can overshoot in both directions.
Where it misleads people
Assuming reversion where there is structural change is expensive. Some declines are permanent, and "it is cheap versus its own history" is not a thesis if the history is no longer relevant.
Related terms
- Value trapA share that looks cheap on the numbers and stays cheap because the business is deteriorating.
- CAPE ratioPrice divided by average inflation-adjusted earnings over ten years, to smooth out the business cycle.
- Economic moatA durable structural advantage that lets a company keep earning high returns without being competed away.
- MarginBorrowing from your broker to buy more than your cash allows, using your portfolio as collateral.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.