A big issue with using indices in this way is not with mean reversion as a concept, but that the data set it uses to derive its mean has changed so frequently that it may not be producing a meaningful average to revert back to.
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A different problem with index-based analysis is that it glosses over huge changes in the component parts of these benchmarks over time. This becomes particularly problematic for those who rely on historical average valuation multiples for an index to draw conclusions about today. Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School have shown how in 1900 over 60 per cent of the value of listed US equities was in rail. Today much of this value is accounted for by technology, which came into existence as a category relatively recently and has undergone huge evolution in the past decade.
At the same time returns on invested capital for the most profitable US-listed companies have exploded since the turn of the millennium. According to McKinsey, ROIC, excluding goodwill, for non-financial companies in the 90th percentile of profitability surged to above 80 per cent by the financial crisis, and further since. This compares to less than 25 per cent for this cohort in the 1970s.
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