When you’re considering investing, you’ll want to put your money in a business that has proven sustainable growth rate over the previous years.

The Compounded Annual Growth Rate (CAGR) is your go to metric for this, instead of a simple Average Annual Growth Rate (AAGR)

Example To Make Things Easier

Take company XYZ as a study:

• 2022 Profit = 1,000,000 EGP
• 2023 Profit = -500,000 EGP
• 2024 Profit = 2,000,000 EGP

AAGR = 125%
CAGR = 41.42%

As you can see, there’s a big difference in growth rate depending on which method you use, so you want to use the most accurate figure you can get.

Don’t worry, you’ll find the calculation formulas below, so you can go and make your own.

Why The Difference?

The problem with AAGR is that it would ignore any potential fluctuation or inconsistencies in the company’s performance over the years. The longer the period you measure, the higher the chance you’ll end up with an inaccurate figure.

CAGR smooths fluctuations and volatility in growth rates across years to give a single consistent growth rate. This helps avoid misleading conclusions that can arise from volatile year-to-year returns, which a simple average might exaggerate.

Think back to 2020, when COVID hit, there was an insane overnight surge in the demand face-mask, gloves, etc.

This was an extreme situation, that resulted in a one-off increase in revenue for these companies. Using a simple AAGR would give an inaccurate projection of their performance over the years, and might trick you into thinking they are good investments.

I’m not saying they’re not. This is just an example of a special fluctuation that would yield an over-inflated expectations for future growth and profitability.

Using CAGR, takes into consideration pervious performance, and adjust the growth rate accordingly to give a clearer picture.

Here’s The Formula For CAGR

CAGR = (Ending Value / Beginning Value)^(1/N) – 1

Real Life Example

Let’s analyze Madinet Masr (MASR) Net Income CAGR:

• 2024 Net Income: 2,946,567,089 EGP
• 2014 Net Income: 186,800,000 EGP
• Period: 10 Years

CAGR = (2,946,567,089 / 186,800,000)^(1/10) – 1

MASR 10 Years Net Income CAGR = 31.76%

Great!! Now, How To Actually Use This

Using the 10 years CAGR ( You can use whatever timeframe you want, I use the 10 years), you can roughly forecast what the company’s future growth would look like, and estimate next few years profits.

Not only would this be a key factor in determining if you should invest in this business or not, it can also be used as one of the key figures to calculate a stock’s fair price.

I’m not saying just because MASR has a CAGR of 31.76% over the last 10 years, it will continue to be so forever. However, it’s not too far fetched to expect similar growth in the next couple of years, maybe even 5 years.

How long can you expect the growth rate to stay around the same figure will depend on your personal judgement and how you see the future for the company’s sector, general market conditions, or even global geopolitical situation.

What’s Next?

Now that you know What The Hell Is A D/E Ratio and What The Hell Is A C.A.G.R, it is time to take the next step into analyzing the fair price of a stock.

Our next stop is What The Hell Is An Annual Discount Rate