Once upon a time long long ago we heard about Arithmetic Mean, Geometric Mean, Harmonic Mean and Standard Deviation. Then we promptly forgot how to use them. People keep asking me ‘When should I use AM and when GM?
For relationship managers this is a very important question. AM is very useful when calculating returns – hey it ALWAYS throws up a higher number! Let us say we need to calculate sensex returns over 30 years it would be a CRIME to use AM.
Let me explain. Let us say there is a company whose profits grew by Rs. 10 crores, Rs. 8 crores and Rs. 12 crores over a 3 year period.
Can I say it grew by an average (AM) of Rs. 8 crores over 3 years?
Sure, I would be right.
However if a company grew its profits from 100 to 200 in 3 years would be right to say it grew by 33% every year? No. Here the GM comes into play. The correct answer is 24%, not 33%.
Also if a company grew by 12%, 14% and 28% over 3 years, can I say it grew by an average of 18% p.a. over the past 3 years? Obviously not
Take a company with sales at Rs. 1000 – and mathematically find out the difference. I am too lazy to do it 🙂 . LOL.
Hope you understood the diff between AM and GM. Both are useful. GM will almost always be less than the AM…remember Sebi saying ‘Only GM as an average return?’ – obviously NOT!! BUT yes they do insist on CAGR. Same thing. They know what they want 🙂
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