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CAGR: Comparing investments with excel formula

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Compounded Annual Growth Rateor CAGR, measures the annual growth rate of anything, including an investment over time. The CAGR is used to calculate growth in investments andestimate the growth of many other business parameters like sales, profits,etc. CAGR gets expressed in percentage.

CAGR helps knowing how an investment has performed during a specified period concerning returns. Returns of an investment every year are subject to fluctuations.

It smoothens these fluctuations or volatility. If one wants to know the average rate at which the investment has grown CAGR calculator is the solution. The most common utility of CAGR is to compare the historical performance of investments and decide which one to invest in.

How does it get calculated?

The CAGR calculator uses the following formula:

CAGR = ((Final value/Starting value) ^(1/N))-1

Steps for calculating CAGR:

Step1: Divide the final value by the starting value

Step2: The result gets raised to the power of 1 divided by N the number of years.

Step3: Subtract the derived results by 1,and you get CAGR

Let us use the following example

Rs. Crore Year 0 Year 1 Year2 Year3 Year4 Year5 CAGR
Revenue 1000 1200 1350 1280 1390 1420 7%
Growth y-o-y 20% 13% -5% 9% 2%

 

Note the fluctuations by yearly growth. The maximum growth was 20%, and the minimum was 2%. Everyyear-on-year growth gets smoothened to a 7% CAGR

Uses of CAGR

Absolute returns

You cannot use the CAGR calculator for comparing two types of investments. If an investment has grown by 100% in five years, it does not mean the money has doubled. Look at the re-investment part as well. That is where CAGR comes in handy.

Compare historical returns

The historical returns of different investments function under similar conditions of volatility, and hence, you need to compare them. TheCAGR calculator compares funds with their benchmarks or matching funds and makes an informed decision.

If you invested in Mutual Funds five years ago, understand the average return per year generated using CAGR and verify if the expectations are met.A peer performance reviewgets done easily using CAGR.

The CAGR calculator also gets used to decide future returns by adding 1 to the CAGR and multiplying the result by the ending value. For example:

Rs. Crore Year 0 Yea r1 Year2 Year3 Year4 Year5 CAGR Year6 (Forecast)
Revenue 1000 1200 1350 1280 1390 1420 7% 1523
Growth y-o-y 20% 13% -5% 9% 2% 7%

 

Disadvantages

It takes only the beginning and ending values. It does not consider the additional investments made during the year. Therefore, it is best for investment done ina lumpsum and not for periodic additions to investments like systematic investment plans (SIPs).

Also, it only considers growth and not the risk factor. You cannot use the CAGR calculator as an isolated tool. You must consider other qualitative parameters for decision making.

 

Disclaimer

ICICI Securities Ltd. ( I-Sec). Enrolled office of I-Sec is at ICICI Securities Ltd. – ICICI Venture House, AppasahebMarathe Marg, Prabhadevi, Mumbai – 400 025, India, Tel No : 022 – 6807 7100.

The substance in this above will not be considered as a greeting or influence to exchange or contribute. I-Sec and members acknowledge no liabilities for any misfortune or harm of any sort emerging out of any activities taken in dependence consequently.

The substance thus above are exclusively for educational reason and may not be utilized or considered as a deal report or requesting of deal to trade or buy in for protections or other monetary instruments or some other item.

Interests in protections market are liable to advertise gambles, read every one of the connected records cautiously prior to contributing. The substance thus referenced are exclusively for enlightening and instructive reason.

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