Two Period CAGR and its Investing Applications

Ever since this since was founded, the CAGR figure has been the go to number in order to determine relative performance as well as forecasting future set growth. The topics addressed previously about this matter are broad in range, but there is one in particular that so far has not been discussed.

As you know, the CAGR of a set is the figure that averages year to year returns of an particular set, but as you probably know the growth trends of LEGO sets after retired do not follow a smooth pattern, as they usually present high volatility as soon as they go EOL and up to a period of around 5 years for most sets, when they traditionally seem to mature. One way to account for this is determining what I call the Two Period CAGR, something that some of you may have seen in some of my reviews for currently available sets.

What does this mean exactly? Well, what we are basically doing when calculating the Two Period CAGR is determining the rate at which a particular set will grow the first few years after it has been retired, while then adding that up to the second growth stage of more modest growth that traditionally follows once a set matures. This calculation has a variety of benefits, but to me the most important one comes down to being able to take the set investors are considering purchasing and comparing it to some similar sets that have already been retired. If investors are able to find at least two comparable sets, one that is still experienced high growth (< 2-4 years) and one that has already matured (> 4 years), then the future value projection can become a lot more accurate and a lot more useful. This is a lot simpler to see with an example, so let's get to it.

(Following numbers are not actual figures, just used for illustrative purposes) (We will assume that all sets are released and retired on the same year)

Let's say you are considering investing in 79003 An Unexpected Gathering, released and retiring on 2013. What you would want to do is go ahead and do some research for similar sets retired on the same theme or at least a theme that can be accurately compared with the LOTR. When researching for these sets, what you want is to find at least two different ones, one that has been retired for around 3 years and one that has been retired for more than 4 years.

Assume that the 2 sets you selected for comparison are:

• The Burrow: retired in 2010 and with a current CAGR of 20%
• Chamber of Secrets: retired in 2007 with a current CAGR of 10%

If you really believe these two sets are comparable to An Unexpected Gathering, then you can make an educated guess that probably the set will experience a high growth period with a CAGR of around 20% for its first 3 years and a more modest 10% CAGR once it has been retired for 6 years. Let's now show step by step what you would need to do next:

1- Set up a table in Excel or a similar program where you will project the future value of the set using the long term growth rate and the longest time period. In this case, those numbers would be the ones for the Chamber of Secrets (10% - 6 Years)

This will give you the expected value after 6 years of retirement.
2- Now that you know the long term final value, all you have to do is figure out the ending value for the short term high growth period using the numbers for The Burrow (20% - 3 years)

At this point, you will now the expected value of this set by the end of the third year according to your calculations, $86 in this case, and will be able to decide if it is a worthy investment based on your holding period.

3- Once you have the ending value for the high growth period, you will need to determine the growth rate the set will need to present on the remaining 3 years that will allow it to have a final CAGR of 10%. You will get that number by calculating the CAGR for the last three years using the following inputs:

Beginning Value = The ending value of the high growth period (86)
Ending Value = the ending value you got in Step 1 using the long term CAGR (89)
Number of years = remaining years after high growth period (3)

This will give you a lower CAGR that will get the long term figure to 10%. In this case this number is only around 0.83%, meaning that our set will grow at that yearly rate for the last three years. Usually, the second period CAGR is not as low as this for a number of different reasons, but I thought it would be good to make it as different as possible from the high growth period.

You see that we end up with exactly the same market value after the 6 year have passed both with the 10% smooth growth and with the 20% and then 0.83% two period growth.

4- You can put the results on a graph so that the results are easier to see.

As said before, you will now have two values that you will use to make your investment decision:

• Value 6 years after EOL: $89
• Value 3 years after EOL: $86

I know it looks complicated, but the more you play with it, the easier it will become. With this you'll be able to know the projected future value at different periods, and that is not only possible with two, you can actually do three or more if you prefer.