What is CAGR?

What is CAGR?

What is CAGR?

Compounded Annual Growth Rate is the rate at which your investment grows over a specified amount of time. It is essentially done to smooth out year-to-year growth rates (which could either be rising or falling) to present a clearer and bigger picture of how much the investment has grown or declined over a certain period.

An Example of how CAGR works

Let’s say we want to invest in a company-branded as ABC Ltd whose profits in the beginning of 2017 were INR 80,000 (Beginning Value).

In the span of another four years, the company faced many ups and downs reflected in its capability of profit-making, with years 2018 and 2019 showing a profit of INR 1,20,000 and INR 90,000 respectively. Finally at the end of 2020, it recorded a profit of INR 2,00,000 (Closing Value).

Now, while calculating CAGR, we do not take into consideration the price fluctuations caused on a year-to-year basis, instead we focus only on the beginning balance, closing balance and the time that elapsed between these metrics.

 

Note: It is assumed that profits generated each year are reinvested in growing the business while calculating CAGR.

Why do we need CAGR?

CAGR in itself represents the steady growth rate of an investment. It could be used to estimate the future or historical growth rates in industries, sectors, any security like stock or even the portfolio that is held by an investor. 

CAGR can be useful in terms of comparing various investments and determining which one has undergone the most growth. This comparison can be drawn to peer companies in the same sector or business as well. 

What should be kept in mind while looking at the CAGR?

CAGR will help you to understand which investment has been historically deemed to give the most returns. 

However, CAGR provides a picture of returns increasing steadily over the time duration. However, in reality, securities, especially stocks have fluctuations or volatility in the way they provide returns to investors. Some periods may have rising returns while others might have declining ones. Therefore, CAGR does not consider the aspect of volatility in its calculation. 

It is also important to understand that the calculation of CAGR is dependent on time and therefore, can be manipulated to show positive results. If a company deliberately chooses a time frame which has only good returns, the CAGR would be inflated and would not provide you with a complete picture, 

Therefore, it’s important as an investor to go through the financials of the company as well and see the top-line and bottom-line figures. A stock investor should also go through risk-adjusted return metrics that take into account the risk inherent in a stock (CAGR ignores risk associated with security). 

 

Some of the sectors in India with a good CAGR projection and market scope:

FY stands for “Financial Year”.

We hope this article could give answers to all the questions that you had in mind about CAGR. But still, if you have any doubt, feel free to ask your question in the comments section below or you can also mail us, we will try to give answers to questions as soon as possible.

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