End of Mean Reversion?
John Huber's analysis of why great companies seem to defy the laws of gravity when it comes to returns on capital
End of Mean Reversion?
Author: John Huber Published: January 4, 2021 Source: Saber Capital
Overview
John Huber examines why powerful companies seem to defy traditional mean reversion, exploring how the internet and digital business models have changed the rules of capitalism.
The Power Law in Markets
Building on work by Aaron Edelheit and Fred Liu, Huber applies the concept of Power Law Distribution to markets:
"Most of the value created comes from a small minority of companies."
This is the 80/20 rule in action: a handful of companies generate outsized returns while most underperform.
Why Mean Reversion Has Weakened
1. Digital vs. Physical
"All the electrons that make up the internet weigh less than a single strawberry."
Digital businesses have fundamentally different economics:
- Instant creation and rapid scaling
- Near-zero marginal cost per new customer
- No inventory, shipping, or time constraints
Example: When COVID hit, Zoom's business grew 4x almost immediately. Physical goods (masks, lumber) hit shortages. But digital "supply" scaled instantly.
2. Data Economics
"When growth requires bits instead of atoms, there is no such ceiling."
Data network effects create winner-take-all dynamics:
- More users → more data → better product → more users
- The feedback loop strengthens with scale
- Incumbents collect "taxes" on the small business ecosystem
3. Buffett's Geico Observation
"Every time someone clicked on a Geico ad, Google got paid."
The fixed cost base (data centers, engineers) doesn't scale with usage. Every additional click above that base is pure profit.
Why Tech Giants Have Durable Moats
The Irony
"Coca-Cola and Proctor & Gamble are seeing cracks in their once-impenetrable moats—a testament to the competition that big tech ironically helped foster."
But while competition increased, certain tech models got MORE dominant as they grew:
- Network effects strengthened with scale
- Data advantages became insurmountable
- Winner-take-all dynamics emerged
Key Insight
"Why do excess returns in some businesses seem more likely to expand than to mean-revert?"
The answer lies in the nature of digital businesses:
- Zero marginal cost of scaling
- Network effects that strengthen with size
- Data moats that compound over time
These create self-reinforcing flywheels that don't follow traditional competitive dynamics.
Implications for Investors
- Understanding power laws — Most returns come from few big winners
- Quality over cheapness — Great businesses can justify higher prices
- Patience — These businesses require time to compound
- Concentration — Diversification may dilute returns
Related Concepts
Source
John Huber, Saber Capital, January 4, 2021.