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A Note on the Law of Large Numbers

About ten years ago, an analyst asked the CEO of one of the world's three largest cell phone companies, "Can you maintain your historical growth of X% for another ten years.?"

Without thinking, the CEO answered something like, "Sure, no problem."

Whereupon the analyst went back to his desk and calculated that in order maintain the historical growth rate, there would by now (2010), have to be seven billion handsets, more than one for every one man, woman, and child, all produced by this one company.

Beyond a certain size (as when you are one of three major companies whose market share totals over 90%), the "hypergrowth"  percentage gains that characterize even medium sized gains are no longer sustainable, because they are being taken off progressively higher bases. Warren Buffett said it best: "Size eventually forges it's own anchor."

In the middle of the past century, IBM could grow at 20% a year for about 20 years. Microsoft did even better for a shorter period of time. But it's also true that "trees don't growth to the sky."

These key principles are often forgotten by growth stock investors.