The "average compound growth rate" is also known as the "annualized
yield rate" or "average rate of return."
It requires using a geometric mean rather than an arithmetic mean.
I've provided two sites below which walk you through how to calculate
this for your own data.
http://www.math.toronto.edu/mathnet/questionCorner/geomean.html
http://campus.murraystate.edu/academic/faculty/larry.guin/FIN632/geometric%20mean.rtf
or
http://216.239.41.104/search?q=cache:3gNkrgvLxrcJ:campus.murraystate.edu/academic/faculty/larry.guin/FIN632/geometric%2520mean.rtf+%22average+compound+growth+rate%22+calculate&hl=en
The reason you can't use a simple arithmetic average is best explained
by example (which I've copied from the second site):
"To see why we need to use the geometric mean return rather than an
arithmetic return, consider the following example. Assume that the
price of a stock is $100. Then, one year later, the price of the
stock has fallen to $50. However, in the following year, the price
rises again to $100. What is the average rate of return per year on
the stock for the two-year period?
If we use an arithmetic return, we would say that the stock fell in
price 50% during the first year and rose 100% in price the second
year. Therefore the average rate of return must be 25% per year, i.e.
(-50% + 100%) divided by 2 years.
Obviously, this is not correct. The average rate of return is zero
percent per year since the price ended where it began two years
earlier. So we need a better method to calculate the average rate of
return - that method is the geometric mean return."
Though your question doesn't explicitly say to use this method for
calculating earnings growth, you should as the same principle applies
to earnings growth as to sales. |
