CAGR (Annual Growth Rate) is and indicator of the return on investment. It measures the rate of return on investment for the entire duration of the investment or also the measure investment appreciation. Typically, the CAGR abbreviation is used. It is actually the geometric mean growth rate.
What is the CAGR indicator used for?
CAGR typically measures investment growth. It is used for investments that are longer than 1 year. It is one of the main figures in the securities analysis. The indicator says how the investment grows at a steady pace (or how it grew) throughout its duration. Its advantage is that it takes into account the overall trend over many years - it therefore filters annual fluctuations (so called volatility) and helps to assess the mean annual increase in revenues - in reality CAGR erases the volatility. This allows to compare investments or investment opportunities with each other.
For a better understanding: for the annual 15% CAGR, the 5-year investment is roughly doubled after the 5-years.
There are many other formulas and methods how to calculate return on investment, e.g. IRR, ROI.
What is the formula for CAGR calculation?
= ((Final Value / Initial Value) ^ (1 / years of investment)) - 1
CAGR is actually the geometric mean of the calculated values. Compared to the arithmetic mean the advantage is that it does not appreciate the actual average annual yield rate because it calculates the total duration of the investment (eg 5 years). This eliminates potential fluctuations (volatility) over the duration of the investment.
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