In financial articles and reports you can often find an index with a non-sound name CAGR. If you suddenly want to evaluate the effectiveness of investments or the average growth of the company for several years quickly and easily – it’s all about it. The CAGR is an average annual growth rate.
CAGR formula is looks like:
t0= beginning period (year, month, etc.)
tn = ending period (year, month, etc.)
V(t0) = beginning value (of investment, profit, etc.)
V(tn) = ending value (of investment, profit, etc.)
Let’s see on example the simplicity of CAGR calculation:
The table shows the company’s revenue from 2009 to 2016. With the help of CAGR, we will be able to estimate the average annual growth rate of the company’s revenue from 2009 to 2016:
- Let’s find the beginning and ending periods:
t0= 2009, tn = 2016
- We will find in the table the company’s revenue in 2009 (the beginning value) and 2016 (ending value):
V(t0) = 195 million rubles, V(tn) = 232.14 million rubles
- Calculate the average annual growth rate of revenue from 2009 to 2016.
CAGR (2009-2016) = (232.14 / 195) ^ (1 / (2016-2009)) – 1 = 2.5%
Thus, for the period from 2009 to 2016, ignoring the volatility of revenue by years, the company grew by an average of 2.5%.
Cagr is widely used in financial and business areas, however, it also has its limitations:
- The CAGR growth rate ignores the volatility. Thus it is not advisable to use CAGR as the only metric for making decisions.
- CAGR is easily manipulated, because the time period can be controlled by the user.
- CAGR can not be considered a reliable growth forecast either. No matter how steady the the past performance has been, there is no guarantee that growth will occur in the future.
Sources: http://www.investopedia.com,www. wikihow.com, www.wikipedia.org