Understanding CAGR
CAGR stands for Compound Annual Growth Rate. It represents the mean annual growth rate of an investment over a specified period of time longer than one year. Unlike simple annual growth, CAGR smooths out the volatility of year-over-year returns, providing a single "growth rate" that makes it easier to compare different investments or projects on a consistent basis.
How to Calculate CAGR
The formula for CAGR is:
CAGR = (EV / BV) ^ (1 / n) - 1
When to Use CAGR
- Comparing Investments: If you invested in Stock A and Stock B 5 years ago, CAGR helps you understand which stock performed better on an annualized basis.
- Business Valuation: CAGR is often used to calculate the future value of a business based on projected cash flows (Discounted Cash Flow).
- Portfolio Planning: Financial advisors use it to project the size of a portfolio in the future to see if it meets retirement goals.
- Market Index Funds: Mutual funds often quote their CAGR over 3, 5, and 10-year periods.