CAGR

CAGR stands for Compound Annual Growth Rate. It is a metric that represents the average annual growth rate of an investment, business, or any value over a specified period of time, taking into account the effect of compounding. In other words, CAGR measures the consistent growth rate of a value from its initial amount to its final amount, assuming that the profits are reinvested at the end of each year during the time period.

CAGR is a useful tool for comparing investments or analyzing the performance of a business over time because it smooths out the fluctuations in growth rates and gives a more accurate representation of the overall growth. It is important to note, however, that CAGR does not account for the risk or volatility associated with an investment or business, and it should be used in conjunction with other metrics to make informed decisions.

Example 1: Imagine you invested $10,000 in a mutual fund with the following returns over a 5-year period:

• Year 1: +20%
• Year 2: -10%
• Year 3: +30%
• Year 4: +5%
• Year 5: +15%

To calculate the CAGR, we first determine the ending value of the investment. In this case:

$10,000 * (1 + 0.2) * (1 – 0.1) * (1 + 0.3) * (1 + 0.05) * (1 + 0.15) = $17,104.50

Now, we can use the CAGR formula:

CAGR = [(Ending Value / Starting Value) ^ (1 / Number of Years)] – 1

CAGR = [(17,104.50 / 10,000) ^ (1 / 5)] – 1 ≈ 0.1141 or 11.41%

So, the CAGR for this investment over the 5-year period is 11.41%.

Example 2: Consider a business that has the following revenue over a 3-year period:

• Year 1: $50,000
• Year 2: $60,000
• Year 3: $75,000

We can calculate the CAGR by using the same formula:

CAGR = [(Ending Value / Starting Value) ^ (1 / Number of Years)] – 1

CAGR = [(75,000 / 50,000) ^ (1 / 3)] – 1 ≈ 0.1454 or 14.54%

In this example, the business experienced a CAGR of 14.54% in its revenue over the 3-year period.