Short The Law of Large Numbers

by Mr Juggles

Mr. Moore said it was possible that Yahoo, in its race to compete with Google, was simply overoptimistic in its forecasts and too eager to appeal to investors. “You are expected to grow every quarter,” he said. “There is a law of large numbers. It just gets tougher and tougher to please the Street.”
-NYTimes article, Ad Sales Fall Short at Yahoo

Every day I hear some wannabe business guru citing The Law of Large Numbers. Listen to the 3Q’06 Google (NYSE: GOOG) conference call and you will not fail to hear the Law mentioned and referenced numerous times by Wall St analysts. However, in each instance, this is a case of silly business people trying to sound knowledgeable and failing miserably.

These empty suits are trying to describe the situation when a company’s increased size makes it more difficult for them to grow, perhaps because it has already penetrated most of its potential market. However, saying just that would be far too straightforward and they instead opt for convoluted and misguided jargon.

Here’s a mini-lesson, dumbed down for the target audience:

The Law of Large Numbers states that when taking a random sample from a population, the observed mean will converge towards the actual mean as the sample size increases. Dumbed down even further: you get better estimates from larger sample sizes. This is The Law of Large Numbers.

Recommendation: Short The Law of Large Numbers. Upgrade Eric Schmidt, CEO of Google, from “Sell on Extreme Arrogance” to “Hold”. After invoking The Law of Large Numbers on one of Google’s initial conference calls, he has changed his rhetoric to focus on The Law of Diminishing Returns, a more appropriate rule for the discussion.

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  1. Agnar Kapundo
    September 21st, 2006 | 12:40 pm

    Excellent advice. May I also suggest going Short on Senior Management that toss around the phrase “Process Driven” when they wouldn’t know a Process if it bit them on the ass? Scratch that: instead read “when the only Process they’re familiar with is Decay?”

  2. Mr Juggles
    September 21st, 2006 | 1:07 pm

    They should more accurately say “The growth of our earnings growth is Decay Driven now that we have hit up against the Law of Diminishing Returns.”

  3. DWM
    September 21st, 2006 | 4:28 pm

    Great post – this has long been one of my biggest pet peeves in Wall Street jargon. Adding to the group, why do so many people misuse the phrase “order of magnitude?” It is very simple – an order of magnitude refers to something 10x larger or 1/10th the size. When people say things like “SG&A should be about $1-$1.2 billion, that order of magnitude” it is simply moronic. Clearly, SG&A for that company is not going to be $100 million or $10 billion…