Death, Taxes, and Reversion to the Mean - Mauboussin

Analysts modeling future corporate financial performance should use past return on invested capital (ROIC) patterns, including a strong tendency toward mean reversion, as an appropriate reference class but rarely do. Full consideration of the difficulty in sustaining high returns should temper the optimism inherent in many models.

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Some companies do post persistently high or low returns beyond what chance dictates. But the ROIC data incorporate much more randomness than most analysts realize.

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We had little luck in identifying the factors behind sustainably high returns.

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This analysis has concrete implications for modeling. We unveil some of the common errors in discounted cash flow models and offer some thoughts on how to improve them.