Reversion To The Mean

“Reversion to the mean” is a simple idea that large companies have a natural, or steady state. No matter how much the stock moves higher or lower, it will sooner or later move back to this “golden mean.” Investors that can catch these stocks as they move back up can have a nice pay day. Charles Carlson, editor of the DRIP Investor, is a believer of this concept, and offers three companies that he believes are still in the process of “reverting to the mean.”

This concept states that, while things can move to extremes in the short run, most things — be it weather patterns, human emotions, and, yes, even stock prices — tend to exist at some steady state, some “golden mean.” Thus, when certain stocks move sharply in either direction, mean reversion says that the stocks will eventually return to some long-run equilibrium level. To be sure, mean reversion generally works well with large companies that have a long track record of performance and decent finances. Mean reversion in stocks does not work very well for new companies that have little history and lousy finances.