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Finance: What is the Sharpe Ratio? 6 Views
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Description:
The Sharpe Ratio is a calculation used by investors to measure the dynamics between risk and reward. TL;DR: lottery tickets=bad.
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Transcript
- 00:00
finance a la shmoop what is the Sharpe ratio well it's a calculation used by
- 00:08
investors in trying to figure out whether their investment was smart or [Sharpe ratio definition on 100 dollar bill]
- 00:12
just lucky or rather it's a measure to measure the amount of risk they took in [Smart and lucky on either side of balance scale]
- 00:18
order to get a given level of reward and remember risk and reward are joined at
- 00:22
the wrist like handcuffed politicians fighting for that one congressional seat [Politicians fighting over a chair]
Full Transcript
- 00:27
in Alaska all right well for example if you spent five bucks on a lottery ticket
- 00:30
and won a million yes the outcome was mathematically good and yes you made 200
- 00:36
thousand times your money but was that a high Sharpe ratio investment no why
- 00:42
because your odds of winning were in fact one in a billion so you were just [Lottery billboard appears]
- 00:46
lucky like extremely lucky not necessarily good on the other hand what
- 00:52
if you had taken a deep dive and looked hard at Amazon in 1998 when it was [Woman with Amazon paper in library]
- 00:56
valued at a tiny fraction of where it's valued today well you could have done
- 01:01
the math on its profit margins which were nearly zero or negative for a very [Person using calculator]
- 01:05
long time you could have thought about how the public markets would perceive a
- 01:09
company growing revenues massively at such a level that in a decade they'd end [Amazon watering can sprinkles over revenues]
- 01:14
up beginning to destroy Walmart you could have looked at the amazing ease
- 01:18
with which product are delivered to lazy homeowners who love not having to get up [Man in frog onesie sitting on couch]
- 01:24
off their fat Duff's and drive to the store and park fighting crowds and angry
- 01:29
union cashiers who are upset to be bothered in the checkout line have you
- 01:33
done all this research and concluded that Amazon would go from a hundred [Amazon revenues graph rises]
- 01:37
million dollars in book sales to hundreds of billions of dollars of sales
- 01:43
of pretty much everything two decades later well then you would have done
- 01:47
high-quality research made a return analogous to your lottery ticket
- 01:52
winnings and maybe not two hundred thousand times but something close but
- 01:55
would have produced a very high Sharpe ratio because the quality of the
- 01:59
research and the risk management along the way was extremely high you also
- 02:04
could have gleaned that Amazon's growth when it was small was the envy of every [BestBuy and Oracle appear and look at amazon chart]
- 02:08
big-box retailer you know like Best Buy every technology firm like
- 02:13
Oracle and all the other establishment companies of the world from banks to
- 02:18
even oil companies probably certainly insurance companies such that for a
- 02:22
price amazon always would have been a relatively easy sale to one of those [Man taping up a box]
- 02:27
guys so that the downside on the investment all along the way was likely
- 02:31
a pretty limited so the bottom line high Sharpe ratios good research good smart
- 02:37
analysis good lottery tickets hugely bad very very bad
- 02:42
although investing in a company called chloroform energy drinks would probably [Man holds bottle of chloroform]
- 02:47
be even worse
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