Law Of Large Numbers

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. 

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. Small Cap

    Refers to stocks with a relatively small market capitalization. ...
  2. Large Cap - Big Cap

    A term used by the investment community to refer to companies ...
  3. Moore's Law

    An observation made by Intel co-founder Gordon Moore in 1965. ...
  4. Appreciation

    An increase in the value of an asset over time. The increase ...
  5. Mega Cap

    The biggest companies in the investment universe, as measured ...
  6. Market Capitalization

    The total dollar market value of all of a company's outstanding ...
Related Articles
  1. Insurance

    Market Capitalization Defined

    Find out the differences between mega-, large-, mid- and small-cap stocks and how each suits different investing styles.
  2. 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.
  3. 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.
  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. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
  7. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  8. Economics

    The Truth about Productivity

    Why has labor market productivity slowed sharply around the world in recent years? One of the greatest economic mysteries out there.
  9. Term

    How Market Segments Work

    A market segment is a group of people who share similar qualities.
  10. Active Trading

    Market Efficiency Basics

    Market efficiency theory states that a stock’s price will fully reflect all available and relevant information at any given time.
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 finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  3. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
  4. Do plane tickets get cheaper closer to the date of departure?

    The price of flights usually increases one month prior to the date of departure. Flights are usually cheapest between three ... Read Full Answer >>
  5. Is Colombia an emerging market economy?

    Colombia meets the criteria of an emerging market economy. The South American country has a much lower gross domestic product, ... Read Full Answer >>
  6. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center