Law Of Large Numbers

AAA

DEFINITION of 'Law Of Large Numbers'

A principle of probability and statistics which states that as a sample size grows, its mean will get closer and closer to the average of the whole population. The law of large numbers in the financial context has a different connotation, which is that a large entity which is growing rapidly cannot maintain that growth pace forever. The biggest of the blue chips, with market values in the hundreds of billions, are frequently cited as examples of this phenomenon. 

INVESTOPEDIA EXPLAINS 'Law Of Large Numbers'

As an example, assume that company X has a market capitalization of $400 billion and company Y has a market capitalization of $5 billion. In order for company X to grow by 50%, it must increase its market capitalization by $200 billion, while company Y would only have to increase its market capitalization by $2.5 billion. The law of large numbers suggests that it is much more likely that company Y will be able to expand by 50% than company X.

The law of large numbers makes logical sense. If a large company continues to grow at 30-50% every year, it would eventually become bigger than the economy itself! Obviously, this can't happen and eventually growth has to slow down. As a result, investing in companies with very high market capitalization can dampen the potential for stock appreciation.

RELATED TERMS
  1. Small Cap

    Refers to stocks with a relatively small market capitalization. ...
  2. Moore's Law

    An observation made by Intel co-founder Gordon Moore in 1965. ...
  3. Large Cap - Big Cap

    A term used by the investment community to refer to companies ...
  4. Mega Cap

    The biggest companies in the investment universe, as measured ...
  5. Appreciation

    An increase in the value of an asset over time. The increase ...
  6. Market Capitalization

    The total dollar market value of all of a company's outstanding ...
RELATED FAQS
  1. What is a company's worth, and who determines its stock price?

    A company's worth - its total value - is its market capitalization, and it is represented by the company's stock price. Market ... Read Full Answer >>
  2. What is a "linear" exposure in Value at Risk (VaR) calculation?

    A linear exposure in the value-at-risk, or VaR, calculation is represented by positions in stocks, bonds, commodities or ... Read Full Answer >>
  3. What is the criteria for a simple random sample?

    Simple random sampling is the most basic form of sampling and can be a component of more precise, more complex sampling methods. ... Read Full Answer >>
  4. What are some examples of ways that sensitivity analysis can be used?

    Sensitivity analysis is an analysis method that is used to identify how much variations in the input values for a given variable ... Read Full Answer >>
  5. What are the benefits of using ceteris paribus assumptions in economics?

    Most, though not all, economists rely on ceteris paribus conditions to build and test economic models. The reason they do ... Read Full Answer >>
  6. How is the 80-20 rule (Pareto's Principle) used in macroeconomics?

    The 80-20 rule was first used in macroeconomics to describe the distribution of wealth in Italy in the early 20th century, ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    Which Mutual Fund Market Cap Suits You?

    Different funds invest in companies with different market caps. Find out which is right for you.
  2. Markets

    Understanding Small- And Big-Cap Stocks

    If you don't realize how big small-cap stocks can be, you'll miss some good investment opportunities.
  3. Insurance

    Market Capitalization Defined

    Find out the differences between mega-, large-, mid- and small-cap stocks and how each suits different investing styles.
  4. Investing Basics

    Invest Without Stress

    Have anxiety? Don't worry. We have your worry-free investing guide right here.
  5. Markets

    An Introduction To Small Cap Stocks

    When it comes to a company's size, bigger isn't always better for investors. Find out more here.
  6. Fundamental Analysis

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
  7. Economics

    What is Deadweight Loss?

    Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  8. Investing

    The Strong Dollar’s (Real) Toll On Tech Stocks

    A large portion of U.S. technology companies’ sales occur overseas, given the strong international business and consumer demand from many U.S. tech firms.
  9. Fundamental Analysis

    How to Calculate a Coverage Ratio

    In broad terms, the higher the coverage ratio, the better the ability of the enterprise to fulfill its obligations to its lenders.
  10. Economics

    How to Do a Cost-Benefit Analysis

    The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted.

You May Also Like

Hot Definitions
  1. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  2. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  5. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  6. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
Trading Center