What Is Compound Annual Growth Rate (CAGR)? Meaning & Why It Matters in Investing

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.

Formula of Compound Annual Growth Rate (CAGR)

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.

Example of Compound Annual Growth Rate (CAGR) Calculation

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.

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.