ShmoopTube

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finance a la shmoop what is the Sharpe ratio well it's a calculation used by

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investors in trying to figure out whether their investment was smart or [Sharpe ratio definition on 100 dollar bill]

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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]

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order to get a given level of reward and remember risk and reward are joined at

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the wrist like handcuffed politicians fighting for that one congressional seat [Politicians fighting over a chair]

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in Alaska all right well for example if you spent five bucks on a lottery ticket

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and won a million yes the outcome was mathematically good and yes you made 200

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thousand times your money but was that a high Sharpe ratio investment no why

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because your odds of winning were in fact one in a billion so you were just [Lottery billboard appears]

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lucky like extremely lucky not necessarily good on the other hand what

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if you had taken a deep dive and looked hard at Amazon in 1998 when it was [Woman with Amazon paper in library]

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valued at a tiny fraction of where it's valued today well you could have done

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the math on its profit margins which were nearly zero or negative for a very [Person using calculator]

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long time you could have thought about how the public markets would perceive a

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company growing revenues massively at such a level that in a decade they'd end [Amazon watering can sprinkles over revenues]

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up beginning to destroy Walmart you could have looked at the amazing ease

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with which product are delivered to lazy homeowners who love not having to get up [Man in frog onesie sitting on couch]

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off their fat Duff's and drive to the store and park fighting crowds and angry

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union cashiers who are upset to be bothered in the checkout line have you

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done all this research and concluded that Amazon would go from a hundred [Amazon revenues graph rises]

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million dollars in book sales to hundreds of billions of dollars of sales

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of pretty much everything two decades later well then you would have done

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high-quality research made a return analogous to your lottery ticket

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winnings and maybe not two hundred thousand times but something close but

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would have produced a very high Sharpe ratio because the quality of the

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research and the risk management along the way was extremely high you also

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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]

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big-box retailer you know like Best Buy every technology firm like

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Oracle and all the other establishment companies of the world from banks to

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even oil companies probably certainly insurance companies such that for a

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price amazon always would have been a relatively easy sale to one of those [Man taping up a box]

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guys so that the downside on the investment all along the way was likely

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a pretty limited so the bottom line high Sharpe ratios good research good smart

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analysis good lottery tickets hugely bad very very bad

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although investing in a company called chloroform energy drinks would probably [Man holds bottle of chloroform]

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be even worse

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