Understanding Compound Annual Growth Rate (CAGR)
The Compound Annual Growth Rate (CAGR) is a financial metric that represents the mean annual rate of growth of an investment over a specified period of time longer than one year. It smooths out volatility and provides a representation of growth as if it had occurred at a steady rate each year. CAGR is a popular metric because it helps investors understand how their investments have performed over time and to compare the performance of different investments.
Why is CAGR Important?
CAGR is particularly useful for:
- Investment Performance: It provides a clear picture of how an investment has grown over several years, ignoring the short-term fluctuations.
- Comparisons: It allows for easy comparison between different investments or projects that have different growth patterns over the same or different time periods.
- Forecasting: While not a guarantee of future performance, CAGR can be used as a basis for projecting future growth if the underlying conditions remain similar.
- Business Valuation: Businesses often use CAGR to measure the growth of revenue, profits, or other key performance indicators over time.
How to Calculate CAGR
The formula for CAGR is:
CAGR = [(Ending Value / Beginning Value)^(1 / Number of Years)] – 1
The result is typically expressed as a percentage.
Example Calculation
Let's say you invested $10,000 in a stock at the beginning of 2019. By the end of 2023 (a period of 5 years), your investment had grown to $25,000.
- Beginning Value = $10,000
- Ending Value = $25,000
- Number of Years = 5
Using the formula:
CAGR = [($25,000 / $10,000)^(1 / 5)] – 1
CAGR = [(2.5)^(0.2)] – 1
CAGR = [1.2011] – 1
CAGR = 0.2011 or 20.11%
This means your investment grew at an average annual rate of approximately 20.11% over those 5 years.
function calculateCAGR() {
var beginningValue = parseFloat(document.getElementById("beginningValue").value);
var endingValue = parseFloat(document.getElementById("endingValue").value);
var numberOfYears = parseFloat(document.getElementById("numberOfYears").value);
var resultElement = document.getElementById("result");
if (isNaN(beginningValue) || isNaN(endingValue) || isNaN(numberOfYears)) {
resultElement.innerHTML = "Please enter valid numbers for all fields.";
return;
}
if (beginningValue <= 0) {
resultElement.innerHTML = "Beginning Value must be greater than zero.";
return;
}
if (numberOfYears <= 0) {
resultElement.innerHTML = "Number of Years must be greater than zero.";
return;
}
var cagr = Math.pow((endingValue / beginningValue), (1 / numberOfYears)) – 1;
var formattedCAGR = (cagr * 100).toFixed(2) + "%";
resultElement.innerHTML = "The Compound Annual Growth Rate (CAGR) is:
";
}
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