CAGR

CAGR Full Form: Compound Annual Growth Rate

Key Highlights

• It is a crucial metric used in finance to calculate an investment or business's average annual growth rate over a specific period.

• CAGR = [(Ending Value/Beginning Value)^1/n] − 1

What is CAGR?

Compound Annual Growth Rate (CAGR) is a crucial metric used in finance to calculate an investment or business's average annual growth rate over a specific period. It provides a more accurate representation of growth by accounting for the compounding effect, which considers both the initial investment and the growth generated over subsequent periods.

CAGR Formula

The formula for calculating CAGR is:

CAGR = [(Ending Value/Beginning Value)^1/n] − 1

Ending Value: Final investment amount

Beginning Value: Initial investment amount

n: Number of years the investment is held

Why is CAGR useful?

• Simple Overview: It provides one clear growth rate instead of multiple annual returns.

• Shows Compounding: Reflects how investments grow when earnings are reinvested.

• Easy Comparison: Helps compare investments with different timeframes or cash flows.

CAGR Example

If you invest ₹10,000, and it grows to ₹15,000 in 5 years:

CAGR= [(15000/10000)^1/5 − 1 = (1.5)^0.2] − 1 ≈ 0.08447 or 8.45%

This means your investment grew, on average, by 8.45% per year.

Key Benefits of CAGR

• Performance Tracking: Measures how well investments have performed.

• Realistic Expectations: Gives an idea of future returns based on past growth.

• Investment Decisions: Helps analysts assess growth potential in companies or sectors.

CAGR Limitations

• Ignores Volatility: Doesn’t show ups and downs during the period.

• Long-Term Focus: May miss short-term trends or market changes.

• Assumes Reinvestment: Assumes all profits are reinvested, which might not always happen.

CAGR Vs XIRR

Feature	CAGR	XIRR
Definition	The compound annual growth rate is the rate at which an investment grows over a period of time, taking into account compounding.	XIRR is used to calculate the annualized rate of return for investments that involve irregular cash flows.
Rate of Return	CAGR considers the internal rate of return.	XIRR considers the average annual growth rate.
Usefulness	CAGR is useful for comparing the returns of different investments over different periods of time.	XIRR is useful for comparing the returns of investments with irregular cash flows.
Limitations	CAGR does not take into account the timing of cash flows.	XIRR can be difficult to calculate for complex investments.