CAGR (Compound Annual Growth Rate): Meaning, Formula, Calculation & Examples
The CAGR full form is compound annual growth rate. It is one of the most commonly used investment metrics to evaluate the performance of an investment over a period of time. It is a powerful tool that can help investors understand the growth rate of their investment and make informed decisions.
In this blog, we will explore the concept of compound annual growth rate in detail, its calculation, its limitations, and its importance in investment analysis. So, let’s dive in and understand everything you need to know about CAGR.
What is CAGR Meaning?
CAGR stands for compound annual growth rate and is a widely used return metric. It records the yearly return generated by an investment, as opposed to the absolute return, which records the point-to-point return from an investment without considering the time required to create it.
The compound annual growth rate is preferred over the other metrics because it provides the average yearly return achieved by an investment based on the initial invested amount, the final value of the investment, and the time period elapsed, allowing returns to be compared across different asset classes. Let us now learn how to calculate compound annual growth rate or CAGR.
How Does CAGR Work?
CAGR, or Compound Annual Growth Rate, calculates the average annual growth rate of an investment over a specific period, assuming that growth is compounded.
Let’s illustrate how compound annual growth rate operates:
Consider an investment starting at Rs 150,000, growing to Rs 220,000 in eight years.
To calculate CAGR, use the formula:
CAGR =(Ending balance/beginning balance)^1/n – 1
By applying the formula, we derive a CAGR of 6.78% for this investment.
This indicates an average annual growth of approximately 6.78% over the eight-year period.
How to Calculate CAGR?
The compound annual growth rate is calculated by taking the ending value of an investment, dividing it by the beginning value, taking the nth root of that number (where n is the number of years), and then subtracting 1 from that result.
CAGR Formula
The compounded annual growth rate formula to find for the compound annual growth rate is as follows:
CAGR =(Ending balance/beginning balance)^1/n – 1
Ending balance = Value of the investment at the end of the investment period
Beginning balance = Value of the investment at the beginning of the investment period
N = Number of years you have invested
Example
Let’s understand this with the help of a CAGR with example. Suppose that Elon invested Rs. 2000 in an equity mutual fund in 2020. The total net asset value (NAV) remained the same in 2020, but in 2021 it increased to Rs. 2100. During the time of maturity (in 2022), the NAV stood at Rs. 2500.
| Year | NAV (in Rs) |
| 2020 | 2000 |
| 2021 | 2100 |
| 2022 | 2500 |
So, the CAGR growth will be 7.72%, or we can say that the NAV of the mutual fund in which Elon had invested grew at a CAGR of 7.72%.
By using the above-mentioned formula, you can calculate the compound annual growth rate manually. However, you can also calculate growth rate in Excel or by using any online CAGR calculator.
Well, calculating the compound annual rate of growth by using a CAGR calculator online is an effortless thing to do. Because all you need to do is put all the values in their respective fields and click on the “calculate CAGR” button.
But when it comes to Microsoft Excel, there are multiple ways to do that. So, let’s look at the rate growth rate calculation in Excel, now !
CAGR Formula Excel
Unfortunately, there is no straightforward compound annual growth rate formula in Excel. Still, you can calculate it by using any of the below-mentioned functions:
- RRI function
- IRR function
- RATE function
- POWER function
The following screenshot depicts an excel calculation of CAGR using the RRI function:
What is CAGR in Stocks?
The CAGR of total stock market returns illustrates the average growth rate. It’s essential to compare expected returns with CAGR before stock market investments to assess profitability.
CAGR aids in long-term analysis, reducing unsystematic risk linked to economic fluctuations. By smoothing short-term variations, it offers insights into a company’s structural performance.
For long-term investments, comparing compound annual growth rate is vital for identifying value investments. Value stocks typically exhibit consistent high CAGRs, ensuring significant long-term capital gains.
How Investors Use CAGR?
People often assess returns in absolute terms. Consider investing ₹2,000 in a mutual fund for three years. At the end of the third year, the investment grows to ₹3,700, a 85% return in absolute terms, almost doubling the money. However, this can be misleading as it doesn’t reveal yearly growth.
CAGR clarifies this:
CAGR = [(3700/2000)^(1/3)] – 1
OR
CAGR = 23%
In essence, the fund yields an average 23% return annually over three years. Compound Annual Growth Rate indicates compounded annual returns, irrespective of yearly fluctuations, helping you understand how your investment grows, even when it doesn’t grow uniformly each year.
Uses of CAGR
CAGR serves various purposes:
- Comparing Investment Performance: It standardizes investment performance assessment, allowing equal evaluation based on average annual growth rather than absolute numbers.
- Long-Term Planning: Compound Annual Growth Rate aids long-term investment planning by estimating potential growth, helping investors project future values and make informed decisions.
- Evaluating Investment Risk: CAGR assesses investment risk. A consistently positive compound annual growth rate over time signals stable, reliable growth attractive to risk-averse investors.
- Assessing Performance: Investors use compound annual growth rate to assess historical performance. Comparison with benchmarks helps gauge investment strategy effectiveness and identify areas for improvement
Why is CAGR Useful for You?
The compounded annual growth rate takes into account the effects of compounding over time. By calculating the average annual growth rate of an investment over a certain period, CAGR provides a clear picture of the investment’s performance. Which can be compared to other investments or market benchmarks.
It is also helpful because it allows you to evaluate the long-term growth potential of an investment, even if its returns have been volatile or uneven over time. Furthermore, it is a reliable way to measure the overall growth rate of an investment and can be used to make informed investment decisions.
CAGR Interpretation
CAGR signifies investment growth over a specific period, representing the average return earned after that duration. It factors in the investment period, calculating returns with minimal volatility.
- Determining a Good CAGR: A specific percentage for a good CAGR in equity investments varies but should ideally surpass savings account interest rates.
- Large-cap Investments: Historically, large, stable companies have provided 8% to 12% returns for long-term investors.
- Small and Mid-cap Investments: These offer higher potential returns but come with higher volatility, historically exceeding 15% for risk-aware investors.
What is CAGR in smallcases?
The compound annual growth rate plays a vital role in:
- Comparing smallcases
- Making a final investment decision
On our platform, we calculate the number of compound annual growth rate on the basis of live data. You can see the CAGR and the time label while going through a smallcase. This not only helps you to compare the smallcases but will also help you understand how the returns of your smallcases have been calculated.
For smallcases that have been live on the platform for less than a year, the compound annual growth rate will show absolute performance. Whereas, for smallcases that have been on the platform for more than a year, it will show calculations by using the compound annual growth rate formula.
Advantages of Compound Annual Growth Rate
One of the most widely used metrics to gauge an investment’s profitability is its compound annual growth rate, which shows how well the endeavour has performed on average over time. The advantages of compound annual growth rate are as follows:
- CAGR considers all underlying variables: The short-term compound annual growth rate takes into account all underlying variables, such as market conditions, that affect the performance of such investments.
- CAGR rules out short-term deviations: When looking at compound annual growth rate over a long period of time, all short-term deviations are ruled out because the market swiftly bounces back from shocks. This allows people to assess the genuine potential of the various companies.
Factors to Consider When Using CAGR
When using the compound annual growth rate to analyze investments, there are several factors that should be considered. Some of the important factors to keep in mind are:
- Time Period: The period of investment considered for calculating CAGR is crucial. A longer investment horizon provides a better view of the returns, whereas a shorter period may be misleading. It is important to use a consistent time period when comparing investments.
- Market Fluctuations: Market fluctuations can significantly impact the compound annual growth rate. An investment that has a higher return over a shorter period may not necessarily provide the same returns over a longer period. It is important to consider market trends and volatility while analyzing investments.
- Risk: CAGR does not take into account the risk associated with the investment. A higher compound annual growth rate may not necessarily be a better investment if it is accompanied by higher risk. Therefore, it is important to analyze the risk associated with the investment along with CAGR.
- Currency Fluctuations: If the investment is made in a foreign currency, currency fluctuations can impact the CAGR. Therefore, it is important to consider currency fluctuations while analyzing the returns.
- Taxes and Fees: Taxes and fees can significantly reduce the returns on investment. It is important to consider the impact of taxes and fees on CAGR while analyzing investments.
Limitations of Compound Annual Growth Rate
The compound growth rate is a helpful tool for analyzing investment performance, but there are some limitations to its use. One limitation is that it assumes a constant growth rate over the entire period being analyzed. Which may not be accurate in real-life scenarios where market conditions and other factors can cause fluctuations in growth rates.
Furthermore, the compound annual growth rate may not be the best metric to use when comparing investments with different risk levels, as it does not consider the variability of returns. For example, a high-risk investment may have a higher CAGR than a low-risk investment, but the latter may provide more consistent returns over time.
NIFTY CAGR
Nifty CAGR refers to the compound annual growth rate of the National Stock Exchange (NSE) Nifty index. The Nifty index represents the performance of the top 50 companies listed on the NSE and is considered a benchmark index for the Indian equity market.
The compound annual growth rate of the Nifty is calculated by taking the annual percentage change in the index level over a specified period of time and compounding those returns over that period. It is a useful measure for evaluating the long-term returns of an investment in the Nifty index. A higher compound annual growth rate indicates better long-term performance of the Nifty, while a lower CAGR indicates lower performance.
IRR vs CAGR
The following table is a comparative analysis of CAGR vs IRR
| Aspects of Comparison | CAGR | IRR |
| Calculation Method | Straightforward and can be done manually. | More complex, often requires financial tools like calculators, Excel, or portfolio accounting systems. |
| Purpose | Measures investment return over a specific period. | Evaluates investment or project performance, especially when multiple cash flows are involved. |
| Applicability | Suitable for simpler investments or periods with consistent growth. | Best for complex investments with varying cash flows. |
| Flexibility | Less flexible, as it assumes a constant rate of return. | More flexible, accommodating varying rates of return. |
| Ease of Comprehension | Easier to understand for straightforward scenarios. | May be challenging for those not well-versed in finance. |
| Suitable Calculation Tool | Easily calculated by hand. | Requires specialized financial tools. |
| Educational Resources | Useful for those learning about investments. | Valuable for those interested in advanced financial topics. |
What is a High CAGR Stock?
A high CAGR stock refers to a stock that has achieved a significant and consistent growth rate over a period of time.
It is generally viewed as a positive indicator of a company’s financial health and growth potential. However, it is important to note that past performance does not guarantee future success and other factors such as market conditions and competition should also be considered when evaluating a stock.
To Wrap It Up…
The compound annual growth rate is an important metric you can use to measure the growth rate of your investments over a period of time. It provides a standardized way to compare the performance of different investment options. And makes it easier to make informed decisions about where to put your money.
However, it is important to keep in mind the limitations of CAGR and to use it in conjunction with other metrics and factors when making investment decisions. You can compare CAGRs on smallcase to build your own low-cost, diversified portfolio which are aligned with your expected returns.
Download the smallcase mobile app today and begin your investment journey!
FAQs
A good CAGR for large companies in an industry ranges from 8% to 12%, whereas high-risk companies aim for a compound annual growth rate between 15% to 25%.
Excel’s CAGR function calculates investment CAGR returns means over a specified time period, commonly used by financial analysts, business owners, and investment managers in spreadsheets.
CAGR (Compound Annual Growth Rate) calculates a single growth rate for a specific period, considering compounding effects. In contrast, the annual return rate rate is a simple average of yearly growth rates, without accounting for compounding.
A negative CAGR signifies losses instead of gains over time.
CAGR represents the average annual growth rate of an investment. A 10% compound annual growth rate means that each year, you earn 10% interest on your initial investment, which is then reinvested, and you earn an additional 10% return on the total amount.
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