What is CAGR (Compound Annual Growth Rate)?
The compound annual growth rate (CAGR) 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 CAGR 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.
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.
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.
The formula 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
Let’s understand this with the help of an example. Suppose 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)|
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 CAGR manually. However, you can also calculate CAGR in Excel or by using any online CAGR calculator.
Well, calculating the compound annual growth rate 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 check them out!
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
Why is CAGR useful for you?
The compound 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.
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 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 CAGR 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 CAGR 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 CAGR. 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 CAGR 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 annual 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 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 CAGR 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.
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.
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!