The Compound Annual Growth Rate (CAGR) is a measure of investment or business growth over time. It is often used to measure the long-term performance of investment projects, portfolios, and company businesses.
Simply put, the CAGR indicates the average annualized compound growth rate of an asset over a period of time.
The formula for calculating CAGR is: CAGR = (Final Value / Initial Value)^(1 / Number of Years) – 1
Where the final value is the ending value of the investment or business over a period of time, the initial value is the starting value of the investment or business over the same period, and the number of years is the duration of the investment or business.
CAGR is widely used in finance and investing because it helps investors better understand the growth of an asset or business in the long run.
For example, suppose a stock grows from an initial price of $100 to a final price of $200 over 5 years. The CAGR can be calculated as:
CAGR = (200 / 100)^(1 / 5) – 1 = 0.1487 or 14.87%.
This means the stock has grown at an average annual rate of about 14.87% over the past 5 years.
When considering stock investments, CAGR can help investors better understand the actual growth of an asset or business, thereby evaluating the long-term performance and potential investment returns of the stock.
Here are 4 cases to illustrate the applications of CAGR in stock investing:
1. Portfolio performance evaluation:
You can use CAGR to evaluate the performance of an investment portfolio. Suppose you hold a multi-stock investment portfolio and want to understand the overall performance of the portfolio.
You can calculate the CAGR of the portfolio to understand the average annual growth rate over a period of time. This can help you evaluate the overall performance of the portfolio and make reasonable investment decisions.
2. Investment decision support:
You can use CAGR to support investment decisions.
Suppose you are considering buying stocks. You can calculate the CAGR of the stock over the past few years to understand its historical performance.
If the CAGR of the stock has performed well, it indicates that the stock has achieved a higher growth rate in the past few years.
3. Business growth assessment:
For corporate investors or business owners, CAGR can be used to assess the growth of a company’s business. Suppose a company has achieved sustained growth in revenue or net profit over the past few years.
Corporate investors can calculate the company’s CAGR to understand the average annual growth rate of the company’s business. This can help investors evaluate the company’s operating performance and make reasonable investment decisions.
4. Compare the performance of different assets:
Investors can use CAGR to compare the performance of different asset classes or investment options. For example, you can calculate the CAGR of stocks, bonds, real estate, and other asset classes to understand their average annual growth rates over a period of time.
This can help you compare the performance of different assets and provide references for asset allocation and investment decisions.
