CAGR | Compound Annual Growth Rate

20 October 2024

CAGR Definition and Calculation

Compound Annual Growth Rate (CAGR) provides a smoothed-out annualized rate of return that takes into account the effect of compounding, which can make it a more accurate reflection of an investment’s performance than a simple average annual growth rate.

The formula for calculating CAGR is as follows:

CAGR = (EV / BV)^(1 / n) – 1

Where:

• EV represents the ending value of the investment or asset at the end of the specified period.
• BV represents the beginning value of the investment or asset at the beginning of the specified period.
• n represents the number of years in the investment period.

CAGR is expressed as a percentage and can be used to compare the past performance of different investments or assets, especially when the time periods being compared are not of equal length. It’s a valuable tool for assessing the growth of investments like stocks, bonds, mutual funds, or the overall performance of a business over several years.

For example, if you invested $1,000 in a stock in 2010, and by 2020, that investment had grown to $2,000, the CAGR over the 10-year period would be calculated as:

CAGR = ($2,000 / $1,000)^(1 / 10) – 1 = 0.0729 or 7.29%

This means that, on average, your investment in the stock grew at a rate of 7.29% annually over the 10-year period.

Calculate CAGR Financial Metric

The Compound Annual Growth Rate (CAGR) is a financial metric used to measure the annual growth rate of an investment or asset over a specified time period. It provides a single rate that represents the steady, constant rate at which an investment would need to grow from its initial value to its final value in order to achieve the same result. CAGR is particularly useful when you want to analyze the performance of an investment or asset over multiple years, as it accounts for compounding.

The formula for calculating CAGR is as follows:

CAGR = [(EV / BV) ^ (1 / n) – 1] × 100

Where:

• EV is the ending value or final value of the investment or asset.
• BV is the beginning value or initial value of the investment or asset.
• n is the number of years or periods over which the growth occurred.

Here’s how you can calculate CAGR with an example:

Suppose you invest $1,000 in a stock in 2010, and it grows to $2,000 by 2020. To find the CAGR for this investment over the 10-year period:

CAGR = [($2,000 / $1,000) ^ (1 / 10) – 1] × 100 CAGR = [(2) ^ 0.1 – 1] × 100 CAGR ≈ 7.18%

So, the CAGR for this investment is approximately 7.18%. This means that, on average, your investment grew at a rate of 7.18% per year over the 10-year period.

CAGR is a valuable tool for comparing the growth rates of different investments or assets over the same time frame and can help investors make informed decisions about where to allocate their capital. It is important to note that CAGR assumes a constant growth rate, which may not always be the case in real-world scenarios.

CAGR Meaning

CAGR Meaning in English, Hindi, Urdu, Tamil, Marathi:

• English: Compound Annual Growth Rate.
• Hindi: आवाजित वार्षिक वृद्धि दर (Aavajit Varshik Vriddhi Dar).
• Urdu: متمیز انسداد سالانہ نمو کی شرح (Mutmaiz Insidad Saalana Numoo Ki Sharah).
• Tamil: சேர்க்கைப் பருவ வளரும் வீக்க வீதம் (Sērkkai Paruva Vaḷarum Vīkka Vītam).
• Marathi: संचयित वार्षिक वाढ दर (Sanchayit Varshik Vadha Dar).

CAGR in Finance

CAGR stands for Compound Annual Growth Rate, and it is a widely used financial metric to measure the annualized growth rate of an investment, asset, or business over a specified period of time. CAGR provides a more accurate picture of growth than simple annual growth rates, especially when the growth rate is not consistent year-over-year.

Here’s how you can use CAGR:

• Calculate the total return: Subtract the beginning value from the ending value to find the total return over the period.
• Determine the number of compounding periods: This is typically the number of years in your investment horizon.
• Use the formula above to calculate the CAGR.

CAGR is useful in various financial contexts, including:

• Investment Analysis: Investors can use CAGR to compare the annual growth rates of different investment opportunities, such as stocks, bonds, or mutual funds.
• Business Growth: CAGR can be used to assess a company’s historical revenue or profit growth over a specific period, helping analysts and investors understand its performance.
• Projected Growth: CAGR can also be used to estimate future values based on historical growth rates. For example, it can help forecast sales or revenue growth for a business.
• Evaluating the Performance of Assets: CAGR can be used to assess the performance of assets like real estate or commodities over time.

CAGR is a valuable tool for understanding and comparing growth rates over time, but it’s important to note that it assumes a constant growth rate, which may not always be the case in real-world scenarios. Nonetheless, it provides a useful approximation for analyzing and making financial decisions.

CAGR in Business

Calculate Business CAGR Growth

In the context of business, CAGR can be used in various ways:

• Revenue Growth: Businesses can calculate the CAGR of their revenue over a specific period to assess the overall growth rate. This can be useful for evaluating the success of a product or service, market expansion, or the overall performance of the company.
• Profit Growth: CAGR can also be applied to measure the compound annual growth of profits or net income. This helps business owners and investors understand how efficiently the company is generating profits over time.
• Market Analysis: Companies can use CAGR to assess the growth of their market segment or industry. It can be used to compare their growth with industry averages and identify potential opportunities or threats.
• Investment Decisions: Investors use CAGR to evaluate the performance of stocks, bonds, mutual funds, or other investments. It helps them understand how their investments have grown or declined over time.
• Business Valuation: When buying or selling a business, CAGR can be a useful tool for valuing the business based on its historical growth rate. It provides a quantitative basis for negotiations.

CAGR in Stocks

Stock CAGR Calculation Guide

CAGR is particularly relevant in the context of stocks and investments as it provides a smoothed and more accurate representation of the annual growth rate compared to simple annual returns.

Here’s how to calculate CAGR for stocks:

• Determine the Initial and Final Values:
  • Start by identifying the initial value (the price at which you purchased the stock).
  • Determine the final value (the current market price or the price at which you plan to sell the stock).
• Define the Investment Period:
  • Decide on the investment period for which you want to calculate the CAGR. It’s usually measured in years.
• Use the CAGR Formula: The CAGR formula is as follows:CAGR = [(Ending Value / Beginning Value) ^ (1 / n)] – 1 Where:
  • Ending Value is the final value of the investment.
  • Beginning Value is the initial value of the investment.
  • n is the number of years in the investment period.
• Calculate CAGR:
  • Plug the values into the formula, and calculate the CAGR.

The resulting CAGR represents the average annual growth rate of your investment over the specified period, assuming the growth has been compounded. It is expressed as a percentage and can provide a more accurate picture of how well your investment has performed compared to a simple average annual return.

For example, if you invested $1,000 in a stock, and after 5 years, it grew to $1,500, the CAGR would be:

CAGR = [(1,500 / 1,000) ^ (1 / 5)] – 1 CAGR ≈ 8.68%

This means that, on average, your investment in the stock grew at a rate of approximately 8.68% per year over the 5-year period.

CAGR is useful for evaluating the performance of stocks or any investment where the value changes over time and you want to understand the annual growth rate on a compounded basis. It helps investors compare the returns of different investments over various time frames and assess their potential for achieving long-term financial goals. Keep in mind that past performance does not guarantee future results, and CAGR is just one tool among many for evaluating investments.

Compound Annual Growth Rate FAQ