CAGR: Comparing investments with excel formula

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

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