CAGR is an essential term for every investor, especially those who choose investment instruments in stocks and crypto assets.
The term CAGR stands for “Compound Annual Growth Rate.” CAGR can be defined as the average annual growth rate of an investment product in a certain period of more than a year.
So, to learn more about CAGR and how to calculate it, let’s see the full review below.
What is CAGR?
CAGR is a term that refers to the rate of return or return required for the investment value to grow from its initial balance to its final balance.
This can be known by assuming the return or profit from the investment is reinvested at the end of the investment period.
The term CAGR can also be used to smooth returns from investment activities.
Thus, it will be easier to understand than using other alternative methods.
However, the CAGR is not an actual number of returns, as it only represents the growth of an investment if it grows at the same rate each year and the profits are reinvested at the end of each year.
In reality, performance like this is almost impossible, but CAGR can be used to understand returns better.
Why is CAGR Important to Use in Investment?
CAGR is considered essential to use in investment because CAGR is the most accurate way to determine and calculate returns that can increase/decrease over time.
Then, investors can compare the CAGR of the two alternatives to evaluate how well a stock performs compared to other stocks in the group/to the market index.
However, the CAGR itself is not a true return number because it is just a representative number.
CAGR is a number that shows how far an investment can grow if the investment grows at the same rate every year and the profits are reinvested at the end of each year.
This is why a performance like this is nearly impossible. However, CAGR can be used to understand returns better.
Thus, investors can compare it with other investment alternatives.
How to Calculate CAGR?
The CAGR calculation formula is the final value divided by the initial value, and then the result is raised to the power of 1 divided by the number of years minus 1.
In the formula, n is the number of years. For example, to calculate the CAGR of a company’s stock investment over five years, we can use the following formula:
(Final Value: Initial Value) 1/n – 1
In the formula above, it is known that n is the number of years. So, to make it easier to understand the procedure above here is an example case:
PT ABC has grown equity in 5 consecutive years, namely 39, 21, 32, 71, and 211.
Referring to the information above, the method for calculating the equity CAGR of PT ABC is as follows:
= Final Value: Initial Value
Then, the number 5.41 is raised to the power of ¼, and the result is 1.5251. This number is then subtracted by 1 to get the final outcome of the CAGR, which is 0.5251.
If converted to a percentage form and multiplied by 10, the CAGR value of PT ABC is 52.51 percent.
CAGR Pros and Cons
CAGR is an investment calculation formula with many advantages. Following are the benefits of CAGR as well as its advantages:
- CAGR can be used to compare issuers with the best equity growth. It will also affect the performance of its shares.
- CAGR can help calculate the compound annual growth of the stocks you choose. The calculations are done quickly because the formula is relatively easy.
- CAGR provides an overview of the growth/decrease in your investment in percentage form.
Besides the advantages, CAGR is also a formula that has drawbacks, namely:
- The formula calculation could be more accurate at CAGR because stock prices fluctuate.
At the end of the year, there may be a price spike, but it may decrease when the market is bearish.
- CAGR is a formula that is difficult to apply to stocks with prices that fluctuate too much and cannot be applied to crypto assets that don’t have a long trading history.
The reason is that price spikes, and declines occur significantly. In this case, the CAGR number can only be used as an illustration and cannot always be relied upon.
Therefore, investors must still conduct a more comprehensive analysis before investing in stocks or crypto assets.
In conclusion, CAGR stands for Compound Annual Growth Rate, which can be interpreted as the average annual growth rate of an investment product in a certain period that is more than a year.
CAGR is essential for investment because it is the most accurate way to determine and calculate returns that can increase or decrease over time.
Among the advantages of CAGR is that it can be used to compare issuers with the best equity growth, can be used to help calculate the compound annual growth of selected stocks, and will provide an overview of the growth/decrease in your investment in percentage form.
After reading and understanding CAGR, you know even more about the types of profitable investments.
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