CAGR: Meaning, Formula, Calculation & Uses

Can you imagine doubling your investment every few years? Now that's the power of understanding CAGR (Compound Annual Growth Rate). In the world of finance, it's not just about what you earn, but how fast you can grow your wealth. Let’s uncover the secret formula behind smart, sustained growth by reading this blog.

What is CAGR?

Compound yearly Growth Rate (CAGR) is a metric that defines the average yearly growth rate of an investment over a given period, assuming that the investment expands or decreases at a constant pace each year. It gives a smoothed, consistent rate of growth that, if applied annually, yields the same final value as the actual variable rate of growth.

Say, for example, if you invested Rs 1,000 in a particular mutual fund, it grew at a CAGR of 10% over five years. It means that, on average, your investment would have increased by 10% each year. However, the actual growth in each year may vary. In the first year, it could be 8%, in the second year, it could be 12%, and so on. By using CAGR, you can get a consistent growth rate that can be utilized for comparison, as it smooths out any fluctuations.

What is the CAGR Formula?

The Compound Annual Growth Rate(CAGR) formula needs only the ending value of the investment, the beginning value, and the number of compounding years to calculate. It is achieved by dividing the ending value by the beginning value and raising that figure to the inverse number of years before subtracting it by one.

Where:

• Ending Value is the final value of the investment.
• Beginning Value is the initial value of the investment.
• Number of Years is the total number of years over which the investment grew.

CAGR is typically expressed as a percentage, so you may multiply the result by 100 to get the percentage growth rate.0

How to calculate CAGR return with CAGR Calculator?

The Compound Annual Growth rate (CAGR) calculator net is a utility tool to calculate the compound annual growth rate of your investment over some time. You will have to enter the value of the initial investment, the expected final value of the investment, and the number of years to calculate the CAGR.

The CAGR calculator net has a formula box where you select the beginning and the ending value of the investment. You must also select the number of years of the investment. The CAGR calculator will display the annual rate of growth of your investment. You can use CAGR to compare the return on investment against a benchmark.

How to calculate CAGR net?

To calculate the Compound Annual Growth Rate (CAGR), you can follow these steps:

• Determine the starting value (the initial investment or any other value you are measuring) and the ending value (the value at the end of the specified period).
• Calculate the total number of years or periods over which the growth occurred.
• Use the formula: CAGR = (Ending Value / Starting Value) ^(1 / Number of Years) – 1.
• Multiply the result by 100 to express the CAGR as a percentage.

 Here’s an example to show the calculation:

Say you invested Rs 10,000 in any mutual fund and after 5 years, it grew to Rs 15,000.

Starting Value: Rs 10,000

Ending Value: Rs 15,000

Number of Years: 5

CAGR = (Rs 15,000 / Rs 10,000) ^ (1 / 5) – 1

CAGR = 0.08447 or 8.45%

The CAGR in this case is approximately 8.45%, indicating that the investment grew by an average of 8.45% annually over the 5 years.

What is a simple annual growth rate?

The Simple Annual Growth Rate (AGR) is a straightforward way to measure how much something has increased or decreased in value over a year. It represents the percentage change from the beginning to the end of a specific period, typically one year, without considering any compounding effects.

How to calculate a simple annual growth rate?

The formula for calculating the Simple Annual Growth Rate (AGR) is:

AGR= (Ending Value−Beginning Value / Beginning Value ) ×100

Where:

• Ending Value is the final value of the investment or metric.
• Beginning Value is the initial value of the investment or metric.

AGR is expressed as a percentage and represents the average annual increase or decrease over a single year. Unlike CAGR, it does not account for compounding.

Example:

Suppose you invested ₹10,000 in a stock at the beginning of the year. By the end of the year, the value of your investment grew to ₹12,000.

Step 1: Identify the Beginning Value and Ending Value:

• Beginning Value = ₹10,000
• Ending Value = ₹12,000

Step 2: Apply the AGR formula:

AGR=(Ending Value−Beginning Value/Beginning Value)×100 =

AGR=(12,000−10,000/10,000)×100

AGR=(2,000 /10,000)×100 AGR=0.2×100 =20%

Result: The Simple Annual Growth Rate (AGR) for your investment is 20%

What is a good CAGR?

A good CAGR (Compound Annual Growth Rate) would depend on the context and the type of investment, market conditions, and your financial goals. Some general guidelines can help determine what might be considered a good CAGR as follows:

1. General Market Benchmarks

• Stock Market: A CAGR of around 7% to 10% means good for long-term stock market investments, as it typically matches or exceeds the historical average returns of major indices like the S&P 500.
• Bonds: A CAGR of 3% to 5% might be considered good for bonds, which are generally lower-risk but also offer lower returns compared to stocks.

2. Inflation

• Beating Inflation: A good CAGR should at least outpace inflation, which is often around 2% to 3% annually in many economies. If your investment's CAGR is lower than inflation, your real purchasing power is declining.

3. Risk and Return

• High-Risk Investments: For high-risk investments (like startups, emerging markets, or small-cap stocks), a CAGR of 15% or higher might be considered good, reflecting the potential for higher returns in exchange for greater risk.
• Low-Risk Investments: For low-risk investments (like savings accounts or government bonds), a lower CAGR, around 2% to 5%, could be seen as acceptable, given the stability and lower risk involved.

4. Investment Horizon

• Short-Term vs. Long-Term: A good CAGR over a short period (e.g., 1-3 years) might be higher (10% or more), while for long-term investments (e.g., 10-20 years), a CAGR of 7% to 10% is often seen as strong and sustainable.

5. Personal Goals:

• Individual Financial Goals: What is considered a good CAGR can also depend on your personal financial goals, risk tolerance, and investment strategy. If your goal is steady, long-term growth, a CAGR of 7% to 10% might be good. If you're aiming for aggressive growth, you might target a higher CAGR.

What is CAGR ratio?

CAGR ratio refers to CAGR (Compound Annual Growth Rate) itself, which is a measure of the average annual growth rate of an investment over a specified period, assuming the profits are redirected at the end of each period.

What Can CAGR growth tell You about?

Compound Annual Growth Rate (CAGR) can offer important insights into how a business or investment performs. Some information that CAGR can provide is as follows,

1. Annual Growth on Average: The compound annual growth rate (CAGR) of an investment over a given period is indicated. It provides a compounded, smoothed rate that, if used annually, would have the same final value.
2. Comparative Analysis: The CAGR makes it easier to compare the rates of growth of various assets or investments. It functions as a common metric for evaluating and contrasting the results of different investments made over the same period.
3. Long-Term Performance: When assessing long-term performance, CAGR is helpful. By reducing short-term investments, it aids investors in understanding how an investment has increased or decreased on an annualised basis.
4. Making Investment Choices: CAGR is a tool that investors frequently use to assess past investment performance and make well-informed decisions regarding current and future investments. It offers a historical viewpoint that can help determine the likelihood of further expansion.
5. Goal Assessment: The CAGR can be used to determine if a particular investment has achieved its financial objectives. Investors can assess performance against expectations by contrasting the actual CAGR with desired rates.
6. Risk Evaluation: Although CAGR doesn’t exactly quantify risk, it can be used to deduce the expectedness of an investment’s growth. While a variable or negative CAGR may signal increased risk, a constant and positive CAGR suggests sustained growth.

What are the Uses of CAGR?

Besides its fundamental utility in measuring investment growth, the Compound Annual Growth Rate (CAGR) has multiple other applications in various financial and business contexts. Discussed below are some of the applications of CAGR:

1. Projecting Future Values: CAGR can be applied to project future values based on previous growth rates. By applying the estimated CAGR to the current value, one may predict the possible future worth of an investment or secure over a particular period. This estimate depends on the assumption that the previous rate of growth will continue.
2. Evaluating Investment Choices: CAGR is beneficial for assessing the past performance of various investment choices. Buyers can use CAGR to determine whether the investment has generated a more steady and attractive yearly return over a certain time range. This supports making educated decisions on where to allot funding.
3. Evaluation of Sales and Earnings Increase: In the setting of businesses, or the compound return formula, can be used to measure the compound annual growth of sales, earnings, or other important performance indicators. This formula provides a consistent standard to evaluate the entire growth course of a company by smoothing out annual fluctuations. By applying the compound return formula, businesses can assess their growth rates over specific periods, aiding in performance benchmarking and strategic planning.
4. Defining Realistic Financial Aims: CAGR can help in defining realistic financial aims for future periods. By analysing past compound growth rates, firms and investors can define rational goals for revenue, earnings, or other financial measures. It gives a measurable framework for setting objectives that consider past success.
5. Examining Sector or Industry Performance: CAGR is beneficial for examining the past performance of entire sectors or industries. CAGR allows investors and analysts to analyse the normal growth rates of different sectors over a certain period, assisting them in identifying trends, opportunities, and areas of concern in the broader market.

Conclusion

Compound Annual Growth Rate (CAGR) is an essential metric for assessing the consistent growth of investments or business performance over time. By smoothing out short-term fluctuations, it provides a clear and reliable degree of long-term growth, making it a valuable tool for informed decision-making and strategic planning. Understanding CAGR helps investors and businesses gain deeper insights into their growth routes and compare performance across different opportunities.

FAQs

Q1.What is the purpose of the CAGR?

Ans. The compound annual growth rate (CAGR) is the mean annual growth rate of an investment over a period longer than one year. It's one of the most accurate ways to calculate and determine returns for individual assets, investment portfolios, and anything that can rise or fall in value over time.

Q2. What is a good CAGR for a market?

Ans. A CAGR in sales of 5-12 per cent is suitable for large-cap companies. Similarly, for small businesses, a CAGR of 15% to 30% is satisfactory. Also, a company's CAGR must be consistent over time.

Q3. What happens if CAGR is negative?

Ans. The compound annual growth rate can be negative. A negative CAGR shows that an investment has decreased over a given period rather than increased.

Q4. What is the rule of 70 in CAGR?

Ans. The Rule of 70 Formula: It means, the doubling time is simply 70 divided by the constant annual growth rate. For instance, consider a quantity that grows consistently at 5% annually. According to the Rule of 70, it will take 14 years (70/5) for the quantity to double.