William Stanley Jevons

• The Bottom Line: William Stanley Jevons was a 19th-century economist whose groundbreaking idea—that value is determined by what one more unit is worth to you—is a secret weapon for thinking like a world-class value investor.
• Key Takeaways:
• What he is: One of the fathers of the “Marginal Revolution” in economics, which shifted the focus of value from past labor costs to future usefulness.
• Why he matters: Jevons teaches us to analyze a business not based on its past glories, but on the profitability of its next investment. This is the core of analyzing capital_allocation and Return on Invested Capital (ROIC).
• How to use his ideas: Apply “marginal thinking” to everything: Is management's next big project likely to create value? Will adding one more stock to your portfolio actually reduce risk, or just add complexity?

Imagine you're wandering through a desert, dying of thirst. A merchant appears and offers you a glass of water. You'd probably trade your Rolex for it. The “utility,” or usefulness, of that water is immense. Now, after you've had that glass, he offers you a second. It's still valuable, but maybe not “Rolex-valuable.” By the tenth glass, you might not even pay a dollar for it. This simple idea—that the value of something depends on how much you already have and what one additional unit will do for you—was the revolutionary insight of William Stanley Jevons (1835-1882). Before Jevons and his contemporaries, economists like Adam Smith and Karl Marx argued that an item's value was based on the labor and resources that went into creating it (the “cost of production” theory). Jevons flipped this entirely on its head. He argued that “value depends entirely upon utility.” Specifically, marginal utility. He didn't ask, “What is the total value of water?” He asked, “What is the value of one more glass of water right now, in this specific situation?” This shift from the “total” to the “marginal” was an earthquake in economic thought. Jevons, a British logician and economist, was a brilliant but quirky figure. He built an early logic machine he called the “Logic Piano” and famously, and incorrectly, tried to link business cycles to sunspots. While the sunspot theory didn't pan out, his core insight about marginal value became a cornerstone of modern economics and, more importantly for us, a powerful mental model for investment analysis. For an investor, the Jevonian way of thinking is a game-changer. It forces us to stop looking in the rearview mirror at what a company has done and start focusing on the windshield to see what it will do with its next dollar of capital.

“In commerce, bygones are forever bygones.” - William Stanley Jevons

This quote is pure value investing gold. It's the 19th-century equivalent of saying that sunk costs are irrelevant. What matters is the future, and Jevons gave us the lens to analyze that future: one decision, one project, one dollar at a time.

While you won't find Jevons' name in Benjamin Graham's The Intelligent Investor, his philosophy is woven into the very fabric of value investing. His ideas are not just academic; they are practical tools for avoiding common investment blunders and identifying truly superior businesses. 1. The Foundation of Smart Capital Allocation Analysis The single most important job of a CEO is capital_allocation—deciding what to do with the company's profits. Should they reinvest in the business, buy another company, pay down debt, or return cash to shareholders via dividends or share_buybacks? Jevons' marginal utility provides the perfect framework for judging these decisions. A value investor must ask: What is the marginal return on the next dollar invested?

• A company might have a fantastic legacy business that earned 25% returns on capital. That's its history. The crucial question is about its future. If management now takes the profits and reinvests them in a new, low-margin venture that only earns 5%, they are destroying value at the margin.
• Thinking like Jevons forces you to analyze the company's growth plans with a critical eye. Is that shiny new acquisition truly going to generate high returns, or is management just empire-building? The “total” story might be great, but the “marginal” story could be a disaster waiting to happen. This is the heart of analyzing a company's ROIC.

2. Understanding the Limits of Diversification Diversification is the investing equivalent of Jevons' water-in-the-desert example.

• Your first stock: If you have all your money in cash, buying your first high-quality stock provides enormous “marginal utility.” It gives you a claim on a real business and potential for high returns.
• Stocks 2-15: Adding more carefully selected, uncorrelated businesses dramatically reduces the risk of any single company failure wiping you out. The marginal utility of each addition is very high. You are building a robust portfolio.
• Stock #50: What is the marginal utility of adding your 50th stock? Very little. You've likely already achieved most of the risk-reduction benefits of diversification. At this point, you're more likely adding complexity and di-worsifying into businesses you don't understand as well, reducing your potential returns.

Jevons' logic helps an investor find the sweet spot, avoiding both the folly of single-stock concentration and the closet-indexing of owning hundreds of stocks. 3. A Framework for Rationality in an Irrational Market Jevons' economic models assumed that people were rational “utility-maximizers.” We know from the school of behavioral_finance and our own experience with mr_market that this is far from true. The market is a manic-depressive creature, swinging from euphoria to despair. So how does a flawed assumption help us? It provides a benchmark of rationality. By understanding what a logical, Jevonian decision looks like, we can more clearly spot the irrational behavior of others and exploit it. When the market sells off a great company's stock by 50% because of a single bad quarter, it's not thinking at the margin. It's panicking about the “total” picture. The value investor, thinking like Jevons, can ask: “Has this temporary setback truly impaired the company's ability to generate high marginal returns on its capital in the future?” If the answer is no, a fantastic opportunity with a large margin_of_safety has just presented itself. 4. The Jevons Paradox: A Warning on Efficiency Gains One of Jevons' most counterintuitive ideas was the “Jevons Paradox.” He observed that as steam engines became more efficient at using coal, the total consumption of coal in England actually increased, not decreased. Why? Because the increased efficiency made using steam power cheaper, which spurred more innovation and more factories, leading to a massive increase in demand. For investors, this is a powerful cautionary tale. When a company announces a huge efficiency program or a technological breakthrough, the first-level thought is, “Great, their costs will go down and profits will go up.” The Jevonian, second-level thought is, “What will they do with those gains?”

• Will they pass the savings to customers to gain market share?
• Will they use the freed-up capital to expand into new, potentially less profitable, markets (the paradox in action)?
• Or will they prudently return the excess capital to shareholders?

The Jevons Paradox reminds us that operational efficiency doesn't automatically translate to shareholder value. It depends entirely on the marginal decisions management makes next.

You don't need a calculator or a spreadsheet to be a Jevonian investor. You just need to cultivate a habit of asking the right questions. This is a method of critical thinking, not a formula.

When analyzing a company, a potential new stock for your portfolio, or even your own financial decisions, apply this three-step questioning process.

1. Step 1: The “What's Next?” Test (for Business Analysis). Look beyond the company's overall historical performance and scrutinize its future plans.
   • Where is the next dollar of capital being spent? Is it on expanding their high-return core business, or on a speculative, “diworsification” venture?
   • What is the likely marginal return on that new investment? Does the CEO talk about it with the same discipline and focus on profitability as the core business?
   • Read the annual report's “Use of Proceeds” section for new debt or equity offerings. This tells you exactly where management intends to point the firehose of new cash.
2. Step 2: The Portfolio Utility Check (for Portfolio Management). Before you buy a new stock, ask yourself about its marginal contribution.
   • Will this one additional holding meaningfully reduce my overall portfolio risk? Or am I just adding another company in the same industry I already own?
   • Do I have the time and mental energy to properly follow this one additional business? Or will it just become “Stock #37,” which I never truly understand? (This is a question of your marginal analytical capacity).
   • Is this opportunity significantly better than my worst current holding? If not, perhaps the better marginal decision is to add to an existing position or simply do nothing.
3. Step 3: The Efficiency-to-Value Bridge (for Corporate Actions). When a company announces good news like a cost-cutting program or a new technology, don't stop there.
   • How, specifically, will this efficiency gain be translated into shareholder value? Look for management's discussion on capital plans.
   • Is there a risk that the “Jevons Paradox” kicks in? Will lower costs just encourage the company to chase low-quality growth? A history of disciplined capital allocation is the best evidence against this.

Let's see how Jevonian thinking helps us dissect two different companies.

This example shows that a company's future value is not determined by its history, but by the chain of marginal decisions its leaders make from this day forward.

• Future-Oriented: It forces you to look forward, which is the only direction that matters in investing. Past results are no guarantee of future returns.
• Sharpens Management Analysis: It provides a powerful framework for judging the quality of a management team. Great operators are also great capital allocators who think at the margin.
• Universal Applicability: The concept of marginal utility applies to everything from analyzing acquisitions and diversification to deciding whether to sell a stock or buy a new car.
• Antidote to “Sunk Cost Fallacy”: It constantly reminds you that past investments (of time or money) are irrelevant to the next decision.

• It's a Mental Model, Not a Formula: You cannot calculate a precise “marginal utility” score. It's a qualitative concept that requires judgment and business acumen.
• The “Rational Actor” Flaw: Jevons' work assumed pure rationality. In the real world, you must combine his logical framework with the psychological insights of behavioral_finance to understand how markets truly work.
• Danger of Spurious Correlation: Jevons' own sunspot theory is the perfect warning. In our data-rich world, it's easy to find patterns and assume causality where none exists. A value investor must stick to business fundamentals—what Jevons called the “mechanics of utility”—rather than chasing macro-economic correlations.

• capital_allocation: The practical application of marginal thinking by a CEO.
• return_on_invested_capital: The key metric for measuring the marginal return on new business investments.
• marginal_utility: The core economic theory that underpins this entire way of thinking.
• diversification: A key area where the law of diminishing marginal utility is on full display.
• mr_market: The irrational character value investors exploit by maintaining a rational, Jevonian mindset.
• behavioral_finance: The study of why investors and markets deviate from the rational model proposed by Jevons.
• circle_of_competence: A principle that helps investors avoid the Jevonian pitfall of making marginal investments in areas they don't understand.