CAGR is the abbreviation of Compound Annual Growth Rate The compound annual growth rate is a business and investing specific term for the smooth annualized gain of an investment over a given time period. CAGR is not an accounting term but remains widely used particularly in growth industries or to compare the growth rates of two investments. It is often used to describe the growth over a period of time of some element of the business for example revenue and units delivered.
CAGR is a good instrument for calculate the return requirements of any value rises and falls over time. Also it shines when you compare two different investing instruments for example stocks. One thing that would be problematic is CAGR doesnt take into account the risk of the investment. So dont take the growth rate too literally. The growth rate might be steep in some periods or even investment can drop and rise later etc. Beware about these edge scenarios and growth rate is not that smooth every time.
First lets look into the formula:CAGR = (EV/BV)1/n -1
BV = Beginning value, EV = End value, n = number of years. If you confused from the formatting it is actually the end of period amount divided by the initial amount. Take the exponent of that one divided by the years and at last subtract 1.
Also here you can find an animation of how to calculate it in Excel:
Lets see some example values. Lets say we want to compare a stock rate growth to Gold CFD. In stock scenario assume we had 10000$ and at the end of 3 years we raised 15000$. On the other hand we have the Gold CFD numbers that we invest 5000$ and got 8500$ at the end of 6 years. Now amounts are different, time periods are also different. To compare rate of returns we need a common type of rate which here is the CAGR - Compound Annual Growth Rate. Entering the numbers to the CAGR calculator you will see that Stock scenario gave us 14.47% CAGR, besides Gold has 9.25% CAGR. Now we know that stock option return rate was far better than Gold in this scenario. You can also play around with the numbers and compare different strategies over time and find out long term winner strategies.