Law Of Large Numbers

What is the '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. 

BREAKING DOWN '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. Sampling Distribution

    A probability distribution of a statistic obtained through a ...
  2. Sample

    A subset containing the characteristics of a larger population. ...
  3. Sampling

    A process used in statistical analysis in which a predetermined ...
  4. Sampling Error

    A statistical error to which an analyst exposes a model simply ...
  5. Covered Interest Arbitrage

    The practice of using favorable interest rate differentials to ...
  6. Representative Sample

    A subset of a statistical population that accurately reflects ...
Related Articles
  1. Markets

    10 Companies With No Debt (DOX,NHTC,PAYX)

    These 10 companies have no debt, a big positive in today's economic environment. Three stand out above the rest.
  2. Managing Wealth

    Consumer Defensive Stocks: Are These 2016's Best?

    These eight consumer defensive stocks meet strict objective parameters for top-tier investment potential in 2016.
  3. Investing

    Explaining Standard Error

    Standard error is a statistical term that measures the accuracy with which a sample represents a population.
  4. ETFs & Mutual Funds

    How This New ETF Tracks Millennial Consumer Habits

    A recently launched ETF aims to track Millennial consumer habits.
  5. Financial Advisor

    How to Pick the Best Stocks? Listen to Customers (AMZN, PZZA)

    Rated top in customer service, these companies have delivered impressive stock performance over the past year.
  6. Managing Wealth

    Want to Beat the Market? Take on Some Risk

    As we head into a sketchy investment environment, you may want to reverse your thinking to find the best opportunities.
  7. Markets

    What is a Representative Sample?

    In statistics, a representative sample accurately represents the make-up of various subgroups in an entire data pool.
  8. Markets

    How to Use Stratified Random Sampling

    Stratified random sampling is a technique best used with a sample population easily broken into distinct subgroups. Samples are then taken from each subgroup based on the ratio of the subgroup’s ...
  9. Investing

    How Are 2015’s Best Stocks Performing YTD?

    Are last year's best stocks still delivering for investors? If yes, why? If no, why not?
  10. Markets

    GM Stock: Capital Structure Analysis

    Learn why GM's enterprise value increased, and get an update on the company's capital structure, including equity and debt capitalization.
RELATED FAQS
  1. What's the difference between a representative sample and a convenience sample?

    Learn the difference between convenience sampling and representative sampling and the advantages and disadvantages of each ... Read Answer >>
  2. How can a representative sample lead to sampling bias?

    Learn how using representative samples alone is not enough to make sampling bias negligible and why elements such as randomization ... Read Answer >>
  3. What is the difference between systematic sampling and cluster sampling?

    Learn about the differences between systematic sampling and cluster sampling, including how the samples are created for each ... Read Answer >>
  4. How can you find the demand function from the utility function?

    Learn about how the utility function can be used to derive the demand function, and how both of these concepts relate to ... Read Answer >>
  5. How do researchers ensure that a simple random sample is an accurate representation ...

    Learn which methods researchers employ to ensure that a simple random sample best approximates the larger population being ... Read Answer >>
  6. What's the difference between a representative sample and a random sample?

    Explore the differences between representative samples and random samples, and discover how they are often used in tandem ... Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center