Join Wayne Winston for an in-depth discussion in this video Computing compound annual growth rate (CAGR), part of Excel Data Analysis: Forecasting.
- [Voiceover] When valuing a company it's important to have a good estimate of how fast the company's revenue is growing. In this video you'll learn how to use the exponential trend curve to estimate the most commonly used measure of revenue growth called the CAGR. In CAGR you might think "Where's the beer?" but CAGR's spelled this way, Compound Annual Growth Rate. And it's very simple to use exponential growth to estimate a company's CAGR over a given time period. Recall for exponential growth when x increases by one the prediction increases by the same percentage.
Take this percentage and subtract one and you have the CAGR or Compound Annual Growth Rate. This is really simple. We take the ratio of the predictions. We start in the second year and we take the ratio of the prediction for the second year to the prediction for the first year. Second year prediction divided by first year prediction, copy that down. And they're all the same because that's the property of exponential growth. When x goes up by one the forecast from the equation will go up by the same percentage.
Subtract one. Your CAGR for Cisco in the 1990s is 77 percent. That's amazing! Cisco was growing at 77 percent a year during the 1990s. Now that just can't continue. As we showed you in the last video if you projected out that growth rate you would have thought in 2014 Cisco would be a $500 billion company. Some analysts really thought that. I mean I saw that in newspapers in the late 1990s. Some people thought in five or six years Cisco would be a $500 billion company.
That just did not come about unfortunately. We'd love to see great growth in all companies, but again when you get a bigger base it's harder to keep growing. I would challenge you to find a stock with this property. I think none exists. Find a stock that grew at least 30 percent per year for 30 years. I am pretty sure there is no stock in US history that accomplished that rate of growth because it's just really hard. When you get big as a company where are you going to find the growth? It becomes harder and harder.
Microsoft, Cisco, and many other companies have fallen prey to this fact. You just can't grow at a huge percentage forever. When you're valuing a company, particularly a new company, do not assume because a new high-tech company grew at a high CAGR or annual growth rate during its early years that it will keep up that growth rate forever. It just doesn't happen. You need to be extrapolating growth far beyond the range of data that you have. In our next video we'll give you a challenge to see how well you've mastered exponential growth.
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- Show time-series data by plotting and displaying information.
- Devise a moving average chart.
- Recognize how to account for errors and bias.
- Interpret and utilize trendlines.
- Determine how to model exponential growth.
- Compute the compound annual growth rate.
- Analyze the impact of seasonality.
- Identify the ratio-to-moving average method.