Compound Annual Growth Rate Calculation can be done by dividing the final value by the starting value raising that amount to the inverse number of periods and then subtracting one. A compound Annual Growth Rate (CAGR) is an annual growth of investments over a specific period.
CAGR Meaning –
CAGR stands for the Compound Annual Growth Rate. CAGR of an investment is the average annual amount it grows over the years assuming profits are reinvested during the period. It is expressed in percentage form. It is the most accurate way to calculate the returns of investments that rise and falls in value over time.
If we talk about the investment returns of any stock or anything in 5 years, we don’t talk about the returns of each year, that’s when we use CAGR. We use the final value, starting value, and time period of an investment to calculate CAGR. Then we use CAGR to understand investment returns. It is also used to understand or determine sales growth, profit growth, and many more.
CAGR Formula –
CAGR Formula can be given as,
CAGR = [ (Final Value / Starting Value) ^(1/N) ] – 1
N – Time Period of an investment
CAGR Example –
Let’s take an example that we have invested Rs 1,00,000 in ABC stock
Compound Annual Growth Rate Calculation –
Let’s talk about an example,
Initial amount invested in ABC stock = Rs 1,00,000
After ending the first year, ABC stock gave 13% returns, then the amount became Rs 1,13,000
After ending the second year, ABC stock gave 19% returns, then the amount became Rs 1,34,470
After ending the third year, ABC stock gave only 2% returns, then the amount became Rs 1,37,159
After ending the fourth year, ABC stock gave 7% returns, then the amount became Rs 1,46,760
Now if we have to talk about the returns on this investment, we know we have made Rs 46,760 in profits, now what about the percentage returns,
% Returns on investment= (46,760 / 1,00,000) * 100
% Returns on investment = 47%
Now, If we talk about the returns, we don’t say that we made 13% returns in the first year, 19% in the second year, 2% in the third year, and 7% in the fourth year, we just talk about average annual returns on investment, that is when CAGR comes into the picture.
Now, we will see how to calculate CAGR,
The formula for CAGR is
CAGR = [(Final Value / Starting Value)^(1/N)] -1
Starting Value = 1,00,000
Final Value = 1,46,760
Time Period = 4 Years
CAGR = [(1,46,760 / 1,00,000)^(1/4) – 1
CAGR = [(1.47)^(1/4)] – 1
CAGR = 1.10 – 1
CAGR = 0.10* 100
CAGR of investment in ABC stock = 10%
Also, Check Fundamental Analysis