By James Bell
The Compound Annual Growth Rate is very helpful in making comparisons between investments. You can see the smoothing effect when you compare year over year (YOY) growth of investments using CAGR, . It is helpful when the volatility of returns confuse you about which one is actually higher over multiple periods. You may see business units or departments use CAGR to show growth over time. Simply put, the CAGR formula takes growth rates from multiple periods and calculates them into a steady growth rate. It is also used for forecasting
= Compound Annual Growth Rate
= Beginning Value
= Ending Value
= First Year of Investment
= Last year of Investment
Some consider this better than an average return formula because it takes into consideration the compounding nature of interest. That is that the investment is compounded over time. This formula does not take risk into consideration. Also, the periods must be consistent when using this formula.
This is the value at the beginning. Time zero if you will. You may also see this in textbooks and other materials as Starting Value.
The ending value is also very straight forward. It is the value at the end of the last year or period.
This is just a year. Year 0 if you will. Just like 2018, 0r 3030.
Similar to the First Year, but it’s the last one. So if your returns go through the end of 2012, then you use 2012. The number of years is important because as you add more years with the beginning and ending values constant, you’ll see your CAGR drop. Another way to look at this subtraction part of the formula is to substitute it with the variable n, such as we did in the article about Compound Interest.
As with many data points, you don’t want to compare two investments on CAGR alone. One reason is that you don’t know the amount of capital invested to get these returns. This formula produces different results than average rate of return. In researching this topic, we did our best to find opponents of CAGR but could not find any. This does not mean that none exist, just that we failed to find any on a topical search.
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