Calculate Compounded Annual Growth Rate (CAGR)
The Compounded Annual Growth Rate (CAGR) is a powerful metric used to determine the average annual growth rate of an investment or business over a specified period, assuming that profits were reinvested at the end of each year. It smooths out volatility, providing a more representative measure of growth than simple average growth. CAGR is particularly useful for comparing the performance of different investments or for forecasting future growth based on historical trends.
What is CAGR?
CAGR is essentially a geometric progression rate. It represents the constant rate at which an investment would have grown each year if it had grown at a steady rate. The formula accounts for the compounding effect, meaning that growth in one period contributes to the base for growth in the next period.
Formula for CAGR
The formula to calculate CAGR is:
CAGR = [(Ending Value / Beginning Value)^(1 / Number of Years)] – 1
Where:
- Ending Value: The value of the investment or metric at the end of the period.
- Beginning Value: The value of the investment or metric at the beginning of the period.
- Number of Years: The total number of years in the period.
Why is CAGR Important?
CAGR offers several benefits:
- Smooths Volatility: It presents a consistent growth rate, ignoring fluctuations that may occur year-to-year.
- Comparability: It allows for easy comparison between different investments or business metrics over the same or different timeframes.
- Forecasting: It can be used to project future values based on historical compounded growth.
- Performance Measurement: It is a standard benchmark for evaluating investment performance.
When to Use CAGR
CAGR is commonly used in:
- Financial analysis to assess investment returns.
- Business performance analysis to track revenue, profit, or user growth.
- Evaluating the long-term performance of assets like stocks, mutual funds, or real estate.