Bayes and Base Rates 2.0: How History Can Guide Our Assessment of the Future

Michael Mauboussin - Managing Director
Dan Callahan, CFA - Vice President

• This is a follow up to our recent report, “Bayes and Base Rates,” which argued that to anticipate what is going to happen, it is useful to start with base rates as a prior probability distribution and to update your view based on new information.
• That report sparked interest and some questions that we address, including how to handle inflation, the appropriate reference class, and groundbreaking technologies.
• Comparing the projected sales growth rates of a couple of companies, including OpenAI, to base rates revealed that these forecasts are highly improbable in the context of history. 
• Base rates are dynamic distributions, and nothing in past results says OpenAI's projected rates of growth are unachievable. 
• Factors working in favor of OpenAI are rapid adoption of the product, high one-year sales growth, and the fact that intangible-intensive businesses have proven they can grow fast. 
• On the other hand, there have been numerous disruptive innovations since 1950, and most of the all-time leaders in sales growth have done so through M&A rather than organically.

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