Key Principle No. 11

Why value investing will always work, mean reversion.

The graph below explains why value investing will always work. In a freely competitive market companies with above average profitability will see that profitability decline over time. Companies with below-average profitability will see their prospects improve. Obviously this will not happen to all companies, but on average it will happen just as sure as sand will pour through the hourglass. It is a force of nature.

And, best of all, Wall Street never catches on to this simple fact. They more often than not simply extrapolate good results to continue forever, and likewise for poor results to continue forever. Over time corporate profitability will revert toward the mean.



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