Reversion to The Mean

Time is the equalizer.  Good things decay and other things flower.  The wise planner, and certainly the wise investor, must notice the time element.

There are many examples in the arts and life.

Percy Bysshe Shelley wrote a poem, “Osymandais” that points out the futility of believing in the permanence of power and position.

“My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!’

Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare
The lone and level sands stretch far away.”

A broken statue of Ramses II appeared in London in 1821 and was the basis.

Eleventh century Persian Poet Attar of Nishapur, tells the story of a king who wanted a method to make him feel happy when he was sad.  His wise men created a ring with the words, “This too shall pass.”  Unfortunately, it worked too well because it made him feel sad when he was happy.

People are impatient.  Good things come to he who waits, seems wrong.  Good things come to he who prepares makes more sense.  The trick is to recognize that good things come and bad things too.  We can become fearful or greedy if we fail to recognize that in time it all evens out.

This too shall pass.

Investors who live in the static of TV news soon lose track of the timeliness factor.  Few things mushroom in value in a quarter.  Even Google, the predominant business of its type, has risen by reasonable multiples of its original value.  From its initial offering in 2004 to today it has increased in value by 15.6 times.  About 28%.  Very nice, but that is Google.  There are few that outperformed it. Yet it has barely doubled since November 2007.  9%. What expectations should you have?

Notice the rule of 72.  72 divided by yield provides the time to double.  If you think a stock should double in 3 years you are implicitly saying I expect to earn something like 24%.  What is the value added that makes it worth 12 times the yield on a government bond?  If you cannot answer that your expectation of 24% is suspect.

As an investor, put time on your side and buy businesses that are likely to continue to be dominant in the industry.  They will not make 24% because at that rate, they become very large, very quickly.  Google has a market cap of $445 billion.  What would they do to create another $445 billion of value?  Challenging at least. Will other competitors  ignore them and let them do it?

In the long run businesses earn a reasonable rate of return and that number is far closer to 10% than 28%.  There will be years where they do badly.  What will investors do then?

In the long run everything evens out.  Approaches the average. Recall this too shall pass.  Investors make a mistake to think that over a long time, yield reversion to the mean won’t happen.

Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Contact: don@moneyfyi.com  

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