What is CAGR?
CAGR stands for Compound Annual Growth Rate. A CAGR is the mean annual growth rate of an investment over a certain number of years. Determining a CAGR is one of the most accurate ways to calculate and work out the returns of a specific investment. You can calculate the CAGR by using a simple formula. Start by dividing the final value of the potential investment by its initial value, then raise this number to the power of one divided by the number of years of the investment. Finally subtract one from this result to get your CAGR percentage.
CAGRs are used to help guide companies to determine what to value their products and services according to their performance and CAGR percentage. Not only are CAGRs one of the most accurate ways to determine the return on investment, they can also tell you how a company has been performing on average over a certain number of years. This can be a great benefit if you are contemplating whether to delve deeper into a stock and can help you decide if the company is worth investing in in the future.
Many companies do not know whether their CAGR is good or whether it needs improving. There is no simple answer to the question of what is a good CAGR as this rate can differ depending on the size of the specific company. Usually, anything under an 8% CAGR is poor, but a good rate really does depend on the specific organisation. For example, companies who have been around for 10 or more years may see a CAGR of 8%-12% which is a good rate of sales for the amount of time they have been in business. Smaller companies should usually aim to see a CAGR of between 10%-20% and start-up businesses may see a much higher rate of growth with numbers as high as 100%.
There are a few limitations of calculating a CAGR. One limitation is that it is only a prediction that calculates only a smoothed rate of growth over a certain period and doesn’t take into consideration any potential factors that may affect the company's growth. Another limitation is that CAGRs are only suitable to be used for periods between 3-7 years as you cannot assume that the rate will remain the same in the future. This limitation also makes it difficult for you to decide whether to invest in that particular company or not as the rate in the future is not shown and therefore difficult to predict.
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