Mean reversion

Mean reversion is the idea that a value sitting unusually far from its own long-run average tends to drift back toward that average over time, simply because extremes are, by definition, unusual and don't tend to persist indefinitely.

Applied to valuation, a ratio like P/E that sits near the top or bottom of a company's own historical range is more likely to compress or expand back toward the middle of that range going forward than to keep drifting further in the same direction, all else being equal. It's a tendency, not a law: a business that keeps genuinely improving, or one whose fundamentals have permanently deteriorated, can hold an unusual multiple far longer than reversion alone would predict, or never revert at all.

Mean reversion is one of three explanations worth checking whenever a ratio sits outside its historical range, alongside a real change in the underlying business and a broader re-rating of how the market prices the whole sector. Confusing genuine reversion with one of those other two causes is a common mistake, since all three can produce the same-looking gap in the numbers.