Investing term
What is Mean reversion?
The tendency of valuations and margins to return to long-run averages over time.
Mean reversion is the tendency of things stretched far from their long-run average — valuations, profit margins, returns — to drift back toward it over time. Sky-high margins attract competitors that compete them down; deeply depressed ones often recover. It's a reason to be skeptical of extremes in either direction and not assume the recent past simply continues.
For example
A company earning unusually fat margins may see rivals pile in and compete them back toward the industry average — mean reversion at work.
Mean reversion is taught hands-on in Stage 15 — Valuation for Investors.
See the lesson →