Death, a slower metabolism and traffic jams are three things in life that you can’t avoid. So is slower growth the bigger an economy or company gets – something investors often forget.
Concerns about the growth rates of Apple (the largest company by market capitalization in the world) and China (the second largest economy in the world) are the latest examples of this. “Apple shares plummet on iPhone sales forecast,” trumpeted the Financial Times on Wednesday, warning that Apple’s growth is slowing. “The worries about China’s slowing growth,” headlined a recent article in The Economist.
The law of large numbers says something that’s already big can’t continue to grow at a rapid pace forever. For a company that generates US$1 billion in revenue to double its sales isn’t easy, but it’s possible. However, for a company that earns (say) US$234 billion in revenue – like Apple in 2015 – doubling revenue is a far bigger challenge. It would be like adding the revenues of 16 companies the size of Tencent, in just one year. Or the entire economy of Greece (US$235 billion) in the form of even more iPhones, Macs and iPads.
The problem is that investors are used to Apple growing fast. As recently as 2012, Apple’s revenues increased by 45% (or US$48 billion), to US$157 billion. In 2015, Apple increased its revenue by even more, around US$50 billion – but that was good for growth of a comparatively modest 28%. That’s like adding the revenue of four companies the size of Facebook – in just one year. Today, adding even 15% to 2015 revenues is like adding all of the revenue oil and natural gas giant CNOOC (US$36 billion) generates in a year. And Apple has indicated that even that might be difficult.
China faces the same challenge. China’s economy has grown an average of 10% per year since 1991. Back in 2003, China’s annual growth added US$165 billion to the economy. That’s like adding a country as big as Kuwait in one year. Today, even growing only 6.5% in a year – on the base of a US$10.8 trillion economy – would be like adding four Kuwaits in a year. That’s a lot more difficult.
The power of compounding can do wonders for your portfolio. But another side of compounding is the law of large numbers, which is what’s hurting Apple and China.
That this “slowdown” in growth is inevitable and unavoidable doesn’t matter. Investors have become accustomed to growth – and it can take a long time for expectations to shift. In a few years, no one will expect Apple to grow at 25% per year. And investors will have gotten used to China not being able to grow 6.5% per year.
But that period of adjustment – to a lower-growth outlook – is a painful one. And for now, every time that investors see the effects of the law of large numbers on Apple and China, they’ll tend to sell.