What is the CAGR, how does it work, how is it calculated, and how can it help boost your dividend investment?
The CAGR measures the annual growth rate of an investment, applicable to both general investments and dividend growth, useful for comparing returns over time.
The CAGR (Compound Annual Growth Rate) is a measure of the annual growth rate of an investment over a specific period of time. It is calculated as the geometric index that provides a constant growth rate for all years of the period, meaning it assumes that the investment grows at a constant compound annual rate.
The formula to calculate CAGR is:
\[ CAGR = \left( \frac{VF}{VI} \right)^\frac{1}{n} - 1 \]
where:
- \( VF \) is the final value of the investment.
- \( VI \) is the initial value of the investment.
- \( n \) is the number of years.
CAGR is useful for comparing the performance of different investments over time, especially when the investments have different time periods. It is important to note that, although CAGR provides a simplified representation of growth, it does not take into account the volatility or risk associated with the investment during the period in question.
How does CAGR apply to dividends?
The Compound Annual Growth Rate (CAGR) can also be applied to calculate the growth of dividends paid by an equity investment over time. This allows investors to assess the effectiveness of different stocks as sources of dividend income by comparing the annual percentage increase in dividend payments.
To calculate the CAGR of dividends, the formula is:
\[ CAGR_{dividends} = \left( \frac{D_{final}}{D_{initial}} \right)^\frac{1}{n} - 1 \]
Where:
- \(D_{final}\) is the most recent dividend amount per share.
- \(D_{initial}\) is the initial dividend amount per share (at the start of the time period being analyzed).
- \(n\) is the number of years between the initial and final dividend.
This calculation provides a view of the average annual growth rate of dividends, helping to identify companies that not only regularly pay dividends but also increase the amount of those payments over time.
It is important to remember that the CAGR of dividends does not consider the reinvestment of dividends or changes in the share price, and that past dividend growth does not guarantee future growth.