Non-Stationary

• The Bottom Line: A non-stationary trend is unpredictable and its past behavior is not a reliable guide to its future, making it the financial equivalent of quicksand for investors who rely on forecasting.
• Key Takeaways:
• What it is: A data series (like a stock price or a company's earnings) is non-stationary if its statistical properties, such as its average and volatility, change over time. It doesn't have a natural long-term level it returns to.
• Why it matters: It is the mathematical reason why market timing is a fool's errand and why you must focus on the underlying business, not the stock's chaotic price chart. It highlights the critical need for a margin_of_safety.
• How to use it: Use this concept as a mental filter to identify truly stable, predictable businesses whose fundamentals are as stationary (or predictably growing) as possible, while recognizing that most market noise is non-stationary and should be ignored.

Imagine two rivers flowing through a valley. The first river is old and established. For centuries, it has carved a deep, defined channel. In the spring, snowmelt might cause it to rise, and during a dry summer, it might fall. But it always, always stays within its banks. If you were to measure its water level every day for 50 years, you'd find a consistent average. A high level today suggests it will likely fall back towards that average, and a low level suggests it will rise. This predictable river is stationary. Its properties are stable over time. The second river is a wild, young beast. It's a torrent of water crashing down a mountainside with no established path. One day it might flow east, the next it might flood a plain and carve a new channel to the west. Its average water level is meaningless because the river's very nature is to constantly change. A high water level today gives you no clue where it will be tomorrow—it could be even higher or it could have vanished entirely. This chaotic, unpredictable river is non-stationary. In the world of investing, many of the most important data series are like that second river. The most famous example is the stock market itself. A stock price chart is a classic non-stationary series. Its “average” price from last year tells you almost nothing about its average price next year. It follows what statisticians call a “random walk”—a path that is impossible to predict from its own history. A non-stationary series is defined by its instability. Its mean, its variance (a measure of how spread out the data is), and its relationship with its own past are all in constant flux. Attempting to forecast the next step in a truly non-stationary series is like trying to guess where a feather will land in a hurricane.

“The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.” - Warren Buffett

This quote gets to the heart of the matter. The non-stationary, uncertain nature of markets creates fear and volatility. For a value investor, this isn't a problem to be solved with a complex forecasting model; it's an opportunity to be exploited with a simple focus on underlying business value.

The concept of non-stationarity isn't just an abstract statistical term; it's a foundational pillar that supports the entire philosophy of value investing. It provides the logical “why” behind many of Benjamin Graham's most enduring principles. 1. It Obliterates the Case for Market Timing: Technical analysts and chart-gazers spend their careers trying to find predictable patterns in stock price movements. The concept of non-stationarity demonstrates this is largely a futile effort. Because stock prices don't have a stable mean to revert to, predicting their short-term direction is a game of chance, not skill. A value investor embraces this. Instead of trying to predict the non-stationary noise of the market, they focus their energy on what is knowable and important: the value of the underlying business. It's the ultimate justification for ignoring Mr. Market's daily mood swings. 2. It Forces a Focus on the Business, Not the Stock: If the stock price is an unpredictable, non-stationary river, then a great business is like the solid bedrock beneath it. The investor's job is to analyze the bedrock, not the water. A truly wonderful business—one with a deep economic_moat—generates fundamentals (revenues, earnings, cash flows) that are far more stationary and predictable than its stock price. A company like Coca-Cola has been growing its earnings in a relatively stable, predictable fashion for decades. Its stock price, however, has experienced wild, non-stationary swings during panics and manias. The value investor's advantage comes from focusing on the predictable bedrock and using the unpredictable river to their advantage—buying when fear drives the price far below the bedrock's value. 3. It Is the Ultimate Argument for a Margin of Safety: If the future is inherently unpredictable (non-stationary), then being “approximately right” is the best we can hope for. This is where Benjamin Graham's central concept of a margin of safety becomes non-negotiable. You don't build a bridge to withstand the average, predictable load; you build it to withstand the chaotic, unpredictable hurricane that might come once a century. Similarly, you don't buy a stock at what you think its fair value is. You buy it at a significant discount to your conservative estimate of its intrinsic value. This discount is your buffer against the unknowable future, the errors in your own analysis, and the wild swings that non-stationarity guarantees. 4. It Helps Differentiate Investment from Speculation: An investment operation, as Graham defined it, is one that “promises safety of principal and an adequate return.” This is only possible if your analysis is based on something stable and predictable—the business fundamentals. Speculation, conversely, often relies on forecasting the unpredictable—betting that a non-stationary price series will continue in a certain direction. Understanding non-stationarity helps you draw a bright line in the sand: are you analyzing the bedrock, or are you betting on the river's current?

You don't need a PhD in statistics to use this powerful concept. It's a mental model that should shape your entire research process. The goal is to find businesses whose fundamental reality is as stationary and predictable as possible.

When you analyze a potential investment, consciously separate the “river” (the non-stationary stock price) from the “bedrock” (the underlying business fundamentals).

1. Step 1: Ignore the Price Chart (Initially).

Before you even look at the stock chart, pull up the company's financial statements for the last 10-15 years. This forces you to analyze the business in isolation from the market's manic-depressive sentiment.

1. Step 2: Chart the Bedrock.

Plot the following key metrics on a simple graph over that 10-15 year period:

• Revenue: Is it a smooth, upward-sloping line, or is it jagged and unpredictable?
• Earnings Per Share (EPS): Does it grow consistently, or does it swing wildly between profit and loss?
• Free Cash Flow: Is the company a consistent generator of cash?
• Book Value Per Share: Is shareholder equity steadily compounding?
• Return on Invested Capital (ROIC): Is the company consistently earning high returns on the capital it employs, or is this figure all over the map?

1. Step 3: Ask “Is this a Stationary River or a Wild Torrent?”

Look at the charts you just created.

• A “Stationary” Bedrock: The lines will be relatively smooth and trend consistently upward. There will be bumps, but the overall direction and character are stable. This is the hallmark of a high-quality business with a durable competitive advantage. Think of companies in stable industries like consumer staples, certain healthcare companies, or dominant software providers.
• A “Non-Stationary” Bedrock: The lines will be jagged, erratic, and without a clear, persistent trend. Earnings may vanish for years at a time. This is common in cyclical industries like mining, airlines, auto manufacturing, or in companies with no real competitive advantage.

The result of this exercise isn't a “buy” or “sell” signal. It's a classification of the business's fundamental nature, which tells you how to proceed.

• If you find a stationary, predictable bedrock: This is a candidate for your circle_of_competence. You can have a higher degree of confidence in forecasting its future earning power. The primary task then becomes waiting for Mr. Market's non-stationary mood to offer you a price that provides a sufficient margin of safety.
• If you find a non-stationary, unpredictable bedrock: This company is fundamentally more speculative. Forecasting its future is extremely difficult, if not impossible. A value investor should approach this with extreme caution. If you choose to invest at all, you must demand a massive margin of safety, perhaps by buying it for less than its net asset value, to protect you from the inherent unpredictability of its operations. For many, the best course of action is simply to put it in the “too hard” pile and move on.

Let's compare two hypothetical companies: “Steady Sip Soda Co.” and “Cyclical Steel Inc.”. Steady Sip Soda Co. sells a branded, popular soft drink. Its business is built on a powerful brand, a global distribution network, and a product that people buy consistently regardless of the economic climate. Cyclical Steel Inc. produces steel, a commodity. Its fortunes are tied directly to the global economic cycle, construction booms, and raw material prices. It has little pricing power. Here's a look at their fictional 10-year revenue and earnings per share (EPS) data.

A value investor looking at this data immediately sees that trying to predict Cyclical Steel's earnings for 2024 is pure guesswork. It's a non-stationary torrent. Steady Sip, on the other hand, offers a basis for a rational forecast. You can have reasonable confidence that its EPS in 2024 will likely be around $4.00. This confidence allows you to calculate a sensible intrinsic_value and wait for the non-stationary stock market to offer you a bargain price.

• Promotes Intellectual Honesty: It forces you to admit what you don't know and cannot predict, which is the beginning of investment wisdom.
• Encourages Long-Term Thinking: By focusing on the long-term, semi-stationary nature of business fundamentals, it naturally steers you away from short-term, non-stationary market noise.
• Reinforces Discipline: It provides a clear framework for saying “no” to unpredictable, speculative ventures, keeping you within your circle of competence.
• Highlights Quality: The search for stationary fundamentals is, in essence, a search for high-quality businesses with durable competitive advantages.

• The Illusion of Stationarity: A business can appear stable for decades and then be disrupted by technology or a change in consumer habits, turning its once-stationary fundamentals into a chaotic, non-stationary mess. ¹⁾ This is why a constant re-evaluation of a company's economic_moat is crucial.
• Confusing Growth with Non-Stationarity: A fast-growing company's earnings are, by definition, not stationary (their mean is constantly increasing). The key is to distinguish between a predictable trend (stable growth) and random, unpredictable fluctuations. Don't mistake a rocket ship for a random walk.
• Oversimplification: While a powerful mental model, non-stationarity is a complex statistical topic. You don't need to run advanced statistical tests, but you should recognize that real-world data is messy and rarely fits perfectly into neat boxes. The goal is to identify businesses that are more predictable, not perfectly predictable.

• margin_of_safety
• mr_market
• mean_reversion
• intrinsic_value
• circle_of_competence
• economic_moat
• speculation