Sunday, February 3, 2008

I wish I had known about the term "mean reversion" while I was going through my various product bubbles. (Wiki definition at bottom of post.)

When I went to get my first loan, I was showing the loan officer my huge increases in sales over the previous few years. "Even if it slows, my sales are still really strong."

The guy just looked at me. "I've heard it before. But sales could reverse overnight."

He gave me the loan, but in the back of my mind, I heard what he said. Didn't really believe, you know, but there was a niggling little doubt planted.

Then I read a talk that a guy gave at the big sports card trade show in Hawaii. He was the publisher of 'hobby' magazines who had gotten into the business through stamps and coins: the thrust of his presentation was, cards had nowhere to go but down, and that it would go so far down we wouldn't believe it.

Again, I heard it, though I didn't act on it. It reminded me of my brief foray into coins and stamps. A visit to a sorry little store in Crescent City where they guy all but told me coins and stamps weren't worth anything. (Strangely similar to what I currently tell card collectors.) And a phone call to a coin and stamp store that had left Bend (Oregon Trail, anyone remember them?) and I called them and said, "Gee, I'd like to carry this stuff, as long as I could make xxx amount," and I quoted what I thought was a really low number.

There was a silence on the other end, and then the guy said, "OH, you never make that much. Not even close."

Later, as cards got bigger and bigger, I ended up opening four stores. I thought I was being very prudent, because my planning included the possibility sales could drop in half and I could still pay overhead.

So sales started to drop, and I complained to my wife, who said, "What makes you think it can't drop to zero?"

She was right. Like a safe dropping through one floor after another, once the drop started happening, I couldn't stop it. To all intents and purposes, sales did drop to zero.

So fads are just an extreme example of swings in sales. But underlying every product I sell, I always try to figure out a 'base', beyond which the product won't drop any further, and I try to keep my overhead break-even point as close to that base as possible.

Of course, reversion to mean also can apply to the numbers when sales drop BELOW the mean average. So then you just have to try to survive until it comes back.

The last example I had was Magic and games overall. I've carried some games from the beginning, so I've gotten a pretty good idea of what the mean average might be, and I knew that we had a ten year stretch where the sales were way beyond that. Gambit thrived in those ten years; but I could see the mean reversion kicking in.

It's truly amazing when I talk to other storekeepers how few of them keep track of this measure. I have an advantage of actually having lived through a bunch of them, but the information is there if anyone wants to look it up, too.

"Mean reversion
From Wikipedia, the free encyclopedia

Mean reversion is a mathematical methodology commonly used for stock investing, but it can be applied to other processes. In general terms the idea is that both a stock's high and low prices are temporary, and that a stock's price will tend to have an average price over time.

Mean reversion involves first identifying the trading range for a stock, and then computing the average price. (Persons using extensive financial analytical techniques establish the average price as it relates to assets, earnings, etc.)

When the current market price is less than the average price, the stock is considered attractive for purchase, with the expectation that the price will rise. When the current market price is above the average price, the market price is expected to fall. In other words, deviations from the average price are expected to revert to the average."

No comments: