Law of Large Numbers

Written By
Paul Tracy
Updated November 4, 2020

What is the Law of Large Numbers?

The law of large numbers states that as additional units are added to a sample, the average of the sample converges to the average of the population.

How Does the Law of Large Numbers Work?

Applied to finance, the law of large numbers implies that the more a company grows, the harder it is for the company to sustain that percentage of growth. 

For example, let's assume recently founded Company XYZ has a market capitalization of $10 million. In year 1, XYZ grows 100% from $10 million to $20 million. Shareholders love XYZ's growth story, and would like the company to continue growing at 100% per year. 

But to do so XYZ would have to grow its market capitalization by $20 million in year 2, $40 million in year 3, $80 million in year 4, etc.  If XYZ was able to grow 100% each year, within 20 years XYZ would be larger than the entire $14 trillion U.S. economy! As companies grow larger, their growth rates must slow.  

Why Does the Law of Large Numbers Matter?

Large cap stocks cannot have the growth rates that small cap stocks have. The law of large numbers tells investors that companies with a small market capitalization have much more room to grow (at a much faster rate) than companies with large market capitalizations. 

But a company will not grow forever. Eventually, a successful company will have to transition away from growth and toward income generation on its way to becoming a cash cow

Ask an Expert
All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Law of Large Numbers.
Be the first to ask a question

If you have a question about Law of Large Numbers, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about Law of Large Numbers, then please ask Paul.

Ask a question Read more from Paul
Paul Tracy - profile
Ask an Expert about Law of Large Numbers

By submitting this form you agree with our Privacy Policy

Don't Know a Financial Term?
Search our library of 4,000+ terms