What is CAGR, and What Does It Stand For?
CAGR stands for Compound Annual Growth Rate. CAGR is particularly important for long-term investors because it provides a clear picture of how an investment has grown over time, accounting for the compounding effect.
For instance, if you invested $10,000 in a stock ten years ago, and today your investment is worth $20,000, CAGR would tell you the annualized growth rate your money grew over the ten-year period.
How Do You Calculate CAGR?
The formula to calculate CAGR might seem a little confusing at first, but it’s relatively straightforward:
CAGR = (Ending Value / Beginning Value) ^ (1/n) − 1
Where:
- Ending Value is the value of the investment at the end of the period.
- Beginning Value is the value of the investment at the start of the period.
- n is the number of years.
Calculate the CAGR of an Investment
For example, let’s say you invested $10,000 in a stock, which grew to $20,000 in 10 years.
To calculate the CAGR of an investment, you would:
- Divide the ending value of an investment by its initial value.
- Raise the result to an exponent of one divided by the number of years.
- Subtract 1.
- Convert the answer into a percentage by multiplying the result by 100.
CAGR = (Ending Value / Beginning Value) ^ (1/n) − 1
CAGR = ($20,000 / $10,000) ^ (1/10) − 1
CAGR = 0.0718 or 7.18%
This means your investment grew at an average rate of 7.18% per year over the ten years.
CAGR helps find the smoothed-out average annual growth rate of a stock, a company’s revenue or profits, or even a fund’s total return.
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How to Calculate CAGR in Excel or Google Sheets
CAGR generally can’t be calculated on a simple calculator because it requires complex exponents. Many investors turn to Excel to calculate CAGR because it’s quick and easy, even if you’re not very good at math or Excel.
This step-by-step guide will show you how to calculate CAGR in Excel. I’ll be using Google Sheets, but the steps are the same if you’re using Excel:
- Input Your Data: Enter the beginning value, ending value, and number of years in three separate cells.
Again, let’s say you invested $10,000 in a stock, which grew to $20,000 in 10 years. This is how the data would look:
- Use the Formula: In a new cell, use the following Excel formula:
=((Ending Value / Beginning Value) ^ (1 / Number of Years)) – 1
You can manually enter the numbers like this:
Or, you can do it a quicker way.
With your beginning value in cell B1, your ending value in cell B2, and the number of years in cell B3, the formula would be:
=((B2/B1)^(1/B3))-1
- Format the Result: To see the result as a percentage, format the cell by selecting “Percentage” in the number formatting options.
What is a Good CAGR?
Determining what constitutes a “good” CAGR depends on the context of what you’re looking at.
Generally, a higher CAGR is more desirable because it indicates faster growth over time. However, what qualifies as a “good” CAGR for a stock price, a company’s financial performance, or and industry’s growth can vary significantly.
Here are a couple of company performance CAGRs that we like to use:
- Stock Prices: We like to see a stock that’s grown at over 9% CAGR because this generally means the stock will outpace the general market and inflation.
- Revenue: Generally, we like to see a company grow revenues at over 8% CAGR. Since we like to see stock prices grow at a 9% CAGR, a company that grows revenues at 8% with stable net income margins will, in turn, see around 8% EPS growth. This will make it more feasible for a stock to see above-average returns.
- Earnings Per Share: We generally like to see a stock grow EPS at over 10% CAGR. Since we like to see stock prices grow at a 9% CAGR, a company that grows EPS at 10%+ could see above-average returns for a sustainable time period.
- Free Cash Flow: We generally like to see a company grow its free cash flow at over 8% CAGR.
Practical Applications of CAGR for Stock Market Investors
CAGR helps long-term investors to:
Compare Stock Performance
CAGR allows long-term investors to compare the growth rates of different stocks or mutual funds over time, even if they have different levels of volatility or different prices. This is particularly useful when deciding between multiple long-term investment opportunities.
Example: Consider two stocks – Visa and Mastercard. They traded at different prices and saw similar growth, so it’s hard to see which stock has a better price performance at first glance. However, when you look at the CAGR figure, you can see that Mastercard saw higher price growth with a 12.8% CAGR, while Visa saw a 9.8% CAGR.
Track Portfolio Performance
By calculating the CAGR of your entire stock portfolio, you can get a clear picture of your investment performance and whether your investment strategy yields the results you’re looking for.
Example: If your portfolio has a CAGR of 15% over 5 years, this indicates that it is growing faster than the long-term market average, and you’ll be building your wealth.
Evaluate Business Performance and Project Future Growth
Investors can use the CAGR of a company’s historical earnings or revenue to assess a company’s past growth and as a reference to project future growth. This is particularly useful when estimating what a stock’s future growth rate will be.
Example: If a company has a 10-year revenue CAGR of 12%, and analysts call for revenue to continue growing at a 10 to 12% CAGR, investors will probably be more confident that the company will grow at a 10 to 12% CAGR than if the stock had seen a 4% revenue CAGR over the past 10 years.
Set Realistic Expectations
Knowing a stock’s historical price, revenue, and earnings CAGR can help set realistic expectations for future returns and growth. Examining their portfolio’s CAGR can also help long-term investors gauge whether their investment strategy is working.
Example: If a stock’s historical CAGR is 8% over the last 5 years, expecting a similar return in the next 5 years might be reasonable, barring any significant market changes.
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Limitations of CAGR for Investors
While CAGR is a powerful tool, it has certain limitations for stock market investors:
- Ignores Volatility: CAGR assumes a constant growth rate, which might not reflect the actual performance of a long-term investment that experienced significant volatility. Since CAGR only accounts for the beginning and ending value, investors should be aware that CAGR smooths returns over a time period and may not fully represent the investment’s performance. CAGR may overestimate or underestimate the true annualized growth rate, so investors should look at the actual growth alongside CAGR.
Example: American Express stock grew from $115 per share to $268 per share over the past five years, representing an 18.5% CAGR, which is good. But the stock didn’t just grow in a straight line at 18.5%. It tumbled down 33.2% during Covid to about $79.50 before growing to $268 per share. This volatility isn’t reflected in the CAGR figure.
- CAGR is Only as Good as the Input Data: An incorrect beginning or ending value can significantly distort the calculated CAGR. This is especially relevant for finding a stock’s price CAGR or forecasting a company’s future growth.
- Risk and Volatility: Companies experiencing incredibly fast growth might also come with higher risk. Investors should consider their risk tolerance because sometimes, a company growing at a steady, lower CAGR might be preferable for those seeking lower-risk investments.
Pro Tip:
- Industry Benchmarks: Companies in different industries tend to have different growth rates. For example, technology companies often exhibit higher CAGRs due to rapid innovation and market expansion, whereas utilities or consumer staples might have lower CAGRs due to their stable, less volatile nature. It makes sense to compare a stock’s growth rates to its peers and other stocks in its industry.
Investor FAQs:
What is CAGR in simple terms?
CAGR, or Compound Annual Growth Rate, is the rate at which an investment grows consistently over a period of time, assuming profits are reinvested each year. It smooths out fluctuations to give a clearer picture of growth.
What’s the difference between CAGR and average annual return?
CAGR reflects the consistent year-over-year growth of an investment, while the average annual return is a simple arithmetic mean of returns over a period, which doesn’t account for compounding. CAGR is typically a more reliable measure for evaluating long-term growth.
What does CAGR stand for?
CAGR stands for compound annual growth rate. It reflects an investment’s mean annual growth rate over a specified period of time longer than one year and accounts for the effect of compounding returns.
How do you calculate CAGR in Excel?
To calculate CAGR in Excel, you can use the formula:
= [(Ending Value / Beginning Value) ^ (1 / Number of Years)] − 1
Alternatively, you can use the RATE function:
= RATE(Number of Years, 0, -Beginning Value, Ending Value)
How does CAGR work?
CAGR works by calculating an investment’s average yearly growth rate over a set time frame. It assumes that gains are reinvested yearly, making it a useful metric for understanding long-term growth.
TIKR Takeaway
CAGR, or Compound Annual Growth Rate, is a helpful metric for investors to understand an investment’s average annual growth over a specific period.
It smooths out the volatility of year-to-year growth and provides a clearer picture of an investment’s overall performance.
The TIKR Terminal offers industry-leading financial data on over 100,000 stocks, so if you’re looking to analyze stocks for your portfolio, you’ll want to use TIKR!
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold positions in any of the stocks mentioned in this article. Thank you for reading, and happy investing!
