Over hundreds of Excess Returns interviews, we’ve asked one closing question to every guest: “If you could teach one lesson to the average investor, what would it be?”
The answers have been remarkable - cutting through market noise to reveal what actually matters. So we’re writing a book to capture the best of them: “The Most Important Investing Lesson: What the World’s Best Investors Would Teach You.”
Rather than wait until publication, we’re learning in public. We’ll be sharing chapter drafts here as we write them, getting feedback, and refining the ideas alongside our readers. Below is our first chapter featuring Michael Mauboussin on base rates. We’d love to hear what you think.
In October 2012, Hurricane Sandy was brewing in the Caribbean, and everyone expected the usual script - the storm would head north, curve northeast, and fade harmlessly into the Atlantic. That’s what hurricanes do. The American weather models confirmed it.
But forecasters using the European model saw something different. They’d dug into decades of historical storm data and found a troubling pattern. When similar atmospheric conditions lined up - a high-pressure system blocking the north, a jet stream bent just so - hurricanes had done the unthinkable before. They’d hooked west instead of curving away.
Seven days before landfall, while American models stuck to the expected story, the European model made a bold call - Sandy would slam straight into the Eastern Seaboard.
It was right. Sandy devastated New York and New Jersey. The American model eventually came around, but that early warning saved lives. The difference wasn’t better technology or lucky guesses. The European model had simply been done a better job of answering a very important question: What happened the last time conditions looked like this?
Michael Mauboussin’s One Lesson: Start With What Usually Happens
When we asked Michael Mauboussin what one lesson he’d teach the average investor, his answer wasn’t about stock picking or market timing. It was about something much more fundamental:
“I think that I would encourage people to learn about and apply base rates as they think about the world of investing. By the way, it’s not just valuable for investing, but really business or your life actually... And again, a base rate, the basic setup is the natural way to think about the world or solve your problems is to gather a bunch of information and combine it with your own inputs and experience and project into the future. And that’s what we all do left to our own devices.”
But Mauboussin argues we should flip this approach: “Using base rates says I’m going to think about what I’m facing now or my problem as an instance of a larger reference class. I’m going to basically ask what happened when other people or organizations were in this position before.”
This shift from the “inside view” to the “outside view” sounds simple, but it’s profoundly unnatural. As he puts it: “It’s a very unnatural way to think because you have to leave aside your own information gathering and your own experience. We all tend to place a lot of value on that. And you have to find and appeal to the base rate, which may not be at your fingertips and often it’s not. So you have to go out and make a little effort to find it. But once you do, I think it reshapes how you think a lot about the world.”
The Hurricane Sandy example isn’t just about weather - it’s about how we process information. European forecasters used what Daniel Kahneman calls the “outside view,” while American models fell into the “inside view” trap. As Kahneman notes, “Pallid statistical information is routinely discarded when it is incompatible with one’s personal impressions of a case.”
Most investors do the same thing the American forecasters did - they get lost in the vivid details of their specific situation and ignore the statistical reality of how similar situations usually play out. Consider Elon Musk’s bold 2015 prediction that Tesla could reach $700 billion in market capitalization within a decade, assuming 50% annual sales growth. A thrilling narrative indeed. But examining data from over 6,700 companies revealed that not one company starting with sales comparable to Tesla’s had achieved sustained 50% annual growth over ten years. The base rate was zero.
The Investing Lesson: Start With Expectations, Not Hope
Mauboussin’s approach to individual investments centers on what he calls “expectations investing” - a framework that forces you to think backwards from price before diving into company analysis.
“Expectations investing has three steps. The first step is to go backwards and say, the only thing we know for sure in this whole equation is the price. So let’s go back and reverse engineer using a discounted cashflow model... and think about what has to happen for this current stock price to make sense, right?”
He uses a perfect metaphor: “If you want a metaphor for that, it would be where’s the bar been set for the high jumper. We don’t know how high that high jumper could jump yet, but we know the bar is set at two feet, five feet, ten feet, wherever.”
Step two brings in the analysis: “Introducing historical analysis, but more importantly, strategic and financial analysis to judge whether that company is going to meet, exceed, or come short of those expectations.” This is where base rates become crucial - you’re not just analyzing this company in isolation, you’re comparing it to similar companies in similar situations.
Research shows this matters enormously. Mauboussin’s analysis of sales growth rates reveals that most companies in the S&P 1500 from 1994 to 2014 achieved three-year compound annual growth rates between 0% and 5%. Growth rates sharply decline in frequency as they move away from this range, illustrating how rare extreme growth outcomes actually are.
But here’s the key insight: “You might notice that that whole discussion goes out the window, right? It’s not really the difference between low multiples. It’s really how will the company perform vis-a-vis what’s priced in, right?”
Step three is the decision: buy, sell, or hold based on your probability-weighted scenarios. As Mauboussin emphasizes: “We argue that coming out of step two, what you should have is a number of scenarios for potential outcomes. And you should attach probabilities to those. So we’re really going to think about the world in expected value terms rather than ‘here’s the answer.’”
This process forces intellectual honesty about what you actually need to believe for an investment to work out.
The Portfolio Lesson: Earn the Right to Use Shortcuts
One of Mauboussin’s most eye-opening insights is about multiples - those PE ratios and price-to-sales figures that investors throw around constantly.
“The point I make over and over is that multiples are not valuation. Let me just stop there. Multiples are not valuation. They are a shorthand for the valuation process. And one should never confuse those two things, right?”
He’s not anti-multiples: “I should just be clear. I use multiples. If you and I were having a casual conversation, I would maybe drop multiples about a particular business. But the key is that you understand the economic implications of the multiples that you’re using.”
The standard is clear: “As I tell my students at the end of our valuation module, you have to sort of earn the right to use multiples. You can use them, but earn the right. And the way you earn the right is to demonstrate that you understand the underlying economic assumptions that are embedded”
This connects to base rates in crucial ways. Mauboussin’s research shows that high valuation multiples often precede below-average returns, reflecting investor expectations that prove too optimistic. While certain companies may maintain premium valuations, history shows this is the exception rather than the rule. His work on competitive advantage duration reveals that most companies experience gradual decline in their ability to earn above-average returns as competition increases and market dynamics change.
The deeper insight: “The assumptions about future value creation, investment needs, all that stuff - that’s implicit in a multiple. It’s implicit... In a DCF model, it is explicit. So the question is, would you rather have something implicit and buried, and then we don’t really know exactly what we’re doing, or explicit and overt, and then we could debate?”
Better to have explicit assumptions you can examine and debate than implicit ones buried in shortcuts that ignore what usually happens to companies over time. This insistence on explicit assumptions over comfortable shortcuts reflects something Mauboussin has observed across competitive domains - a pattern that explains why getting better doesn’t always mean winning more.
The Life Lesson: The Paradox of Skill Applies Everywhere
Mauboussin’s most counterintuitive insight comes from what he calls the “paradox of skill” - an idea he learned from Stephen Jay Gould’s analysis of why no one has hit .400 in baseball since Ted Williams in 1941.
“When you think about skill, you can think about it on two levels. The first is absolute skill. And I think we’d all agree... that if you look around the world, not just investing, but business and sports or whatever it is, that the absolute level of skill has never been higher.”
But here’s the paradox: “The second issue though, is the one that’s more important for our discussion, which is relative skill, which is the difference between the very best and the average participants in each field.”
In baseball, the standard deviation (the volatility around the average) of batting averages has collapsed even as absolute skill has risen. Ted Williams was a three-standard-deviation event. Today, a three-standard-deviation hitter would bat .380 - amazing, but nowhere near .400.
The same thing happens in investing: “We measure by looking at essentially the equivalent of batting average, which is the standard deviation of alpha. And historically that’s come down a lot.”
This creates a crucial insight about markets: “You think about how many smart people go into this industry. And how motivated they are and how hardworking they are and how thoughtful they are. It just defies logic that there’s no skill. There’s huge amounts of skill. It’s just, that’s the problem. And that skill gets reflected in prices.”
As absolute skill rises across any domain, the margin between winners and losers narrows, making luck appear more important even as skill becomes more critical.
Understanding this paradox helps you calibrate expectations and focus on what you can actually control - which brings us back to starting with what usually happens before getting seduced by what makes this time feel different.
All The New Questions Mauboussin Left Us With
Mauboussin’s framework sounds logical, but applying it consistently raises some uncomfortable questions about how we actually make decisions.
There’s the humility question: Are we really willing to start with statistics that suggest our optimistic plans might not work out? Base rates often paint a sobering picture. Most market-entry attempts fail. Most acquisitions destroy value. Most new products miss targets. Are we prepared to let these realities inform our thinking, or do we prefer to start with our exciting story?
Then there’s the reference class question: How good are we at identifying what situations actually compare to ours? When Elon Musk predicted Tesla could grow at 50% annually for a decade, the base rate from 6,700 similar companies was zero. But was that the right reference class? Maybe Tesla really was different. How do you tell legitimate uniqueness from wishful thinking?
The shortcuts question cuts deep: How many of our investment decisions rely on multiples we haven’t really earned the right to use? When we say a stock trades at 15 times earnings, do we actually understand what growth rates, margins, and returns on capital that implies? Or are we just using numbers because they feel scientific?
And there’s the skill question: In a world where the paradox of skill makes everyone better but outcomes more random, how do we stay motivated to improve? If rising absolute skill makes relative skill harder to express, what’s the point of getting better?
Finally, there’s the meta-question about our own track record: What are the base rates on our own judgment? How often have our past investment decisions, career moves, or major life choices actually worked out as planned? Are we better at predicting outcomes than the average person thinks they are?
Mauboussin’s base rates force a kind of intellectual humility that’s uncomfortable but necessary. They suggest that most of the time, we’re not as special as we think we are, and our situations aren’t as unique as they feel.
But maybe that’s exactly why they work. In a world where everyone thinks they’re the exception, being grounded in what usually happens can be a real competitive advantage. Just ask the forecasters who saw Sandy coming.
So here’s what we’re left wondering: What reference class do you belong to? When was the last time you checked the base rates before making a big decision? And are you brave enough to start with the outside view, even when the inside view feels so much more compelling?