One of the things we have to be aware of is that there is no law of gravity in finance. Yes, there are some variables that should be mean-reverting. The classic example are corporate profit margins. When profit margins are high, the industry may be disrupted by new entrants who are willing to provide the same service or product at a lower cost and with lower margins, hence driving profit margins lower. When profit margins are low, some businesses will not be able to survive and leave the market, providing growth opportunities and less competition to the survivors. In a less competitive environment, profit margins can increase again.
There is no law of gravity in finance
There is no law of gravity in finance
There is no law of gravity in finance
One of the things we have to be aware of is that there is no law of gravity in finance. Yes, there are some variables that should be mean-reverting. The classic example are corporate profit margins. When profit margins are high, the industry may be disrupted by new entrants who are willing to provide the same service or product at a lower cost and with lower margins, hence driving profit margins lower. When profit margins are low, some businesses will not be able to survive and leave the market, providing growth opportunities and less competition to the survivors. In a less competitive environment, profit margins can increase again.