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CAGR stands for Compound Annual Growth Rate. It reflects the smoothed annual growth rate of an investment, assuming the profits are reinvested every year over a given time period. It is a crucial tool for investors seeking to measure how their investment has performed over time, accounting for compounding returns.
Rather than showing returns year-by-year, CAGR offers a consistent average growth rate that represents how an investment has grown from its beginning value to its ending value.
CAGR helps you compare the performance of different investments over various timeframes by eliminating the effect of short-term market fluctuations. It provides a single, standardised growth rate which helps in setting investment expectations and goals.
Whether you're looking at mutual funds, equities, or business revenues, CAGR gives a reliable and comparable measure of performance.
To calculate CAGR, you need the starting value, ending value, and the investment duration in years. It shows the average annual growth rate, assuming the investment grew steadily, smoothing out short-term market fluctuations.
Here's the standard CAGR formula in text form:
CAGR = [(Ending Value / Beginning Value)^(1 / Number of Years)] – 1
Once the formula is applied, the result is typically expressed as a percentage.
Let’s say you invested ₹1,00,000 in a stock, and its value after 5 years became ₹1,61,051.
Using the CAGR formula:
CAGR = [(161051 / 100000) ^ (1/5)] - 1
CAGR = [1.61051 ^ 0.2] - 1
CAGR ≈ 10%
So, your investment rose at an average rate of 10% per annum over 5 years.
To calculate the CAGR of a company’s revenue, profit, or stock price:
Determine the initial and final value of the metric (e.g., revenue).
Count the number of years between these two values.
Use the same CAGR formula:
CAGR = [(Final Value / Initial Value)^(1 / Number of Years)] – 1
This provides an accurate measure of how consistently the company has grown over that period.
A negative CAGR indicates that the value of an investment or metric has declined consistently over the period in question. It is a sign that the investment is shrinking year-on-year on an average compounded basis.
For example, if a stock was worth ₹1,000 five years ago and is worth ₹600 today, the CAGR will be negative.
Compound Annual Growth Rate (CAGR) is a valuable tool in financial analysis, commonly used to compare investment returns across mutual funds, stocks, or portfolios over a specific period. It also helps forecast future performance based on historical growth and is often used to track a company’s revenue, profit, or asset growth. Additionally, CAGR supports benchmarking by enabling comparisons between companies within the same industry.
While CAGR is a helpful metric for measuring long-term investment growth, it's important to understand both its strengths and its shortcomings before using it for analysis.
Aspect |
Advantages |
Limitations |
|---|---|---|
Simplicity |
Easy to understand and calculate |
Assumes consistent growth, which is rare in reality |
Comparison |
Useful for comparing different investments over time |
Ignores interim volatility or risk |
Applicability |
Works across asset classes like equities, mutual funds, and businesses |
Not ideal for short-term or extremely volatile investments |
CAGR is ideal for long-term evaluation, but it should not be the only measure for investment decisions.
In stock investing, CAGR represents the annualised growth rate of a stock’s price over a specific timeframe. It helps investors understand how well a stock has performed, accounting for the power of compounding.
If you're comparing two stocks over five years, CAGR can reveal which one grew at a steadier and potentially more profitable rate.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
A 10% CAGR means your investment grows at a compounded rate of 10% annually. For instance, if you invest ₹10,000 at 10% CAGR for five years, it would grow to approximately ₹16,105.
A 12% CAGR is generally considered strong, especially for long-term investments. In the context of large-cap mutual funds, a CAGR between 10% and 12% over five or more years is viewed as healthy and stable.
To calculate CAGR in Excel, you can use the formula:
= ((Ending Value / Beginning Value) ^ (1 / Number of Years)) - 1
For example, = ((161051 / 100000) ^ (1 / 5)) - 1 returns 10%. Alternatively, Excel’s RATE function can be used for more complex scenarios involving periodic investments
CAGR shows the average annual growth rate assuming compounding and smooths out volatility, making it more suitable for long-term analysis. In contrast, growth rate is typically calculated year-on-year and may fluctuate significantly based on market conditions.
CAGR assumes a lump-sum investment with consistent annual growth, while XIRR takes into account irregular or multiple investments and the exact dates of cash flows, making it more appropriate for SIPs and varied investments.
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