The CAGR Formula
Measures the Compound Annual Growth Rate.
The CAGR formula can be used to calculate the Compound Annual Growth Rate
(CAGR) of a financial ratio such as earnings per share
The calculation evens out any ups and downs in growth over the period of time by only using the initial and final values of earnings per share in the calculation.
Why Use CAGR?
The CAGR is commonly used to show how quickly an investment, or certain aspects of it, such as earnings per share or sales, have been growing over time.
For earnings per share, I like to use a 10-year period of earnings per share values if possible and require at least a 10% compound earnings per share growth over that period as one of my margin of safety requirements when considering an investment in a company.
If you follow the margin of safety link above, you will see that Benjamin Graham used a different formula to measure earnings per share growth when determining a margin of safety.
A specific company’s compound annual growth rate of earnings per share can then be compared with that of competitors or with the industry as a whole.
Usually,the bigger the growth the better - but you may have to pay a premium for the growth. So called 'growth' companies are identified in part by their high CAGR values.
The Formula for CAGR
The CAGR formula has three inputs in the compound annual growth rate calculation:
- Beginning value
- Final value
- Length of time between the values, usually in years.
The formula for the compound annual growth rate is:
((Final Value/Beginning Value)^(1/N of Years))-1
A spreadsheet is useful for performing this calculation.
To use a spreadsheet to calculate CAGR, proceed as follows:
- open a worksheet page, click on a cell and copy the formula above into the cell and insert an equals sign(=) in front of it
- then substitute your numerical values for Beginning Value, Final Value and Number of Years
As an example, I have used values for the global bionic ear company Cochlear that are displayed below:
and obtained the result 0.14, or 0.139 if the cell is set to three decimal places. Try it yourself using these values and see how you go.
Converting this result to a decimal number gives a compound annual growth rate of earnings per share of 14%, or 13.9% to be more precise. I hope you agree!
This value exceeds my requirement of a 10% increase in earnings per share growth and satisfies one of my requirements for a margin of safety if I was considering an investment in Cochlear.
Being able to calculate a compound annual growth rate for some aspects of a company's operations such as earnings per share growth can assist in determining a margin a safety when choosing investments.
Inserting the CAGR formula above into a spreadsheet and substituting numerical values allows you to calculate CAGR with relative ease.
The related articles below examine the importance of each of the measures in more detail.
- is a strategy where an investor seeks out stocks that they they consider to have good growth potential. They can be identified using the CAGR formula.
Earnings per share - provides a measure of the profitability of a company. Investors like to see growth in this financial ratio over time.
Margin of safety- is a term coined by Benjamin Graham to indicate that one should look for companies whose shares are trading for less than their true worth. Earnings per share growth is one of seven things he considered in identifying a margin od safety.
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