Compound Annual Growth Rate (CAGR): Formula, Calculation
The Compound Annual Growth Rate (CAGR) is a metric used to measure the growth of a specific investment or financial asset over a period of time. It shows how fast an investment or financial asset grows year after year.
In this article, we will explore what the Compound Annual Growth Rate is and how you can calculate it. We will also look at examples of how you might use the CAGR calculator in your daily investing pursuits.
What is the Compound Annual Growth Rate?
The Compound Annual Growth Rate, also known as CAGR, is a metric used to measure the growth of an investment or financial asset over the years.
In other words, it shows the rate of change in an investment or financial asset from one year to the next. The CAGR can be calculated by taking the annual change in an investment or financial asset and dividing it by the annual change in a reference period.
CAGR Formula and How to Use It
Here’s the CAGR formula in its mathematical form:
CAGR = (FV / PV) 1 / n – 1
When using this CAGR formula, you will have to enter the future value of the investment in question in the place of “FV” and the present value of the investment in the place of “PV.” Then, in place of “n,” enter the number of years since the investment was made. Lastly, perform the function ‘n-1’ and enter the value in the formula. It will return the CAGR on the said investment.
Let’s look at an example to better understand how it works.
Consider, for example, that you invested Rs. 40000 in a fund in 2010. Now, assume that the investment that you have made will be worth Rs 80000 in 2025. You can now use the CAGR formula above to calculate the growth that you have earned annually with his fund.
CAGR = (80000/40000) 15/15-1
CAGR = 7.18%
A CAGR of 7.18% means that you earned a return of a little over 7% annually on your investment in the said fund for ten years.
If you’re working with a large set of data, you should not perform calculations for each set. Instead, use the dedicated CAGR formula for Excel.
CAGR formula in Excel: ‘=POWER (Ending Value/Beginning Value, 1/9)-1’.
Terms to Understand Before Using the CAGR Formula
To calculate growth using the CAGR formula, you need the following information:
- Annual change in the investment or financial asset: This is the total increase from one year to the next. For example, if an investment increases by 10% in one year and then increases by another 10% in the following year, that is also a 10% increase.
- Annual change in a reference period: This is the increase from one year to the next that you are comparing the investment or financial asset. For example, if an investment increases by 10% in one year and then increases by another 10% in the following year, the reference period is the following year.
- Annual compound interest rate: This is the interest rate the investment earns on your initial investment. For example, if an investment earns 10% annual compound interest, you can use this rate to calculate the growth using the CAGR formula.
Uses of Compound Annual Growth Rate
These are the two common uses of CAGR:
- Looking at Investment Returns Over Time
When evaluating the returns of an investment or financial asset, the CAGR metric can help investors and financial advisors see how the return has grown over time. It can help determine whether the current return is satisfactory or whether it is time to switch investments.
- Track the Sustainability of a Business Model
CAGR can also help determine the sustainability of a business model.
For example, if you are evaluating a company’s growth over a certain period of time, you can then compare this growth to the overall growth of a particular industry. If a company is growing faster than the overall industry, it might indicate that it is having success.
Common CAGR Applications
- Investment Returns
When investors are trying to decide whether to keep investing in a certain financial product or asset, CAGR can help them determine whether they have made the right decision. In other words, if they have kept the same amount invested over time, they may have made the right decision.
- Business Model Valuation
When investors look at how long a business model is likely to last, CAGR can help them decide if it’s worth continuing to hold on to their investment.
- Asset Valuation
When investors are trying to determine the value of their assets, such as investment property or businesses, CAGR can help determine the growth of the asset over time.
CAGR Calculator and Its Benefits
A CAGR calculator is an online tool. It is designed to allow the user to enter the variables involved in calculating CAGR.
Once the variables have been entered, the calculator returns a value, which is the CAGR. There are many benefits to using an online CAGR calculator.
- It eliminates the chances of any errors in calculation. CAGR is often used to make vital business and financial decisions. An incorrect CAGR can prove disastrous for an investor. Therefore, ensuring that the calculation is error-free is critical.
- A CAGR calculator makes the calculation easy. A user must enter the data, and the calculator returns the CAGR in numbers. The entire process takes less than a minute.
- You can use a CAGR tool to test various scenarios before investing. It would give you an idea of the end result in each scenario before you invest. It can help you avoid investing in the wrong stock, property, etc.
Conclusion
Calculating CAGR can help investors, financial advisors, and business owners determine the sustainability of their investments in terms of growth and sustainability. It allows them to make informed decisions about their investments and the prospect of growth.
When calculating CAGR, it is vital to ensure that all the entered values are free of errors. To be 100 percent sure of the calculation, you can use an online CAGR calculator.
Whenever performing financial calculations, remember to use calculators built by reputed financial institutions like Piramal Finance. Reading their detailed blogs will give you an idea of how to use CAGR in day-to-day decision-making.