The Compound Annual Grwoth Rate (CAGR) – denotes the mean annual growth rate of an investment over any period greater than 12 months (the year) – is the backbone of all financial reporting and all reported returns from investment. It enables the conversion of a set of random digits touching a non-linear ascent of a bar chart to an easily digestible and rational number. It is hard to think of any financial report, global or Indian, that is lacking in CAGRs.
CAGR can be defined mathematically as follows:
CAGR = (Ending Value / Beginning Value) ^ (1 / n) - 1
Where:
Ending Value is the value of the investment at the end of the period.
Beginning Value is the value of the investment at the beginning of the period.
n is the number of years.
The formula yields a benign-sounding smoothed annual rate of return, a number that strips away short-term volatility and shows how your investment really performs on the scale of years.
CAGR is also of critical consequence in India, where disclosure is the means to combat rampant financial fraud and increase accountability among public-sector entities. For instance, regulatory agencies like the Securities Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) have a number of directives and frameworks that make extensive use of CAGR to guide the creation of standards and guidelines for financial reporting that will ensure its consistency across comparable entities.
The Indian government promotes the use of CAGR in several contexts:
Stock Market Analysis: CAGR allows investors to compare the historical performance of stocks and indices. Some of the indices commonly used to judge the market is the BSE Sensex or the Nifty 50 over say 10 years.
Economic indicators: CAGR helps to track GDP, industrial production and other indicators of the economy’s health and direction more closely by reflecting growth better than simple average annual percentage change.
Corporate Financial Reporting: Companies report CAGR in their annual reports to demonstrate growth (as measured by revenue, profit and other financial numbers) for the preceding year. This is especially important in an effort to attract investment and raise funds.
A CAGR calculator is an automatic tool that helps you to calculate CAGR. Such calculators are free and easy to use online. Investors, analysts and college students all make use of these calculators. Easy steps to using a typical CAGR calculator are given below.
Input Beginning Value: Enter the initial value of the investment.
Input Ending Value: Enter the final value of the investment.
Input Number of Years: Specify the period over which the investment has grown.
Calculate: The calculator will apply the CAGR formula and provide the annual growth rate.
These calculators are likely to have interest-accrual graphs and graphics, do-compare-it-to-your-income-and-see features, and a way of adjusting for inflation.
Simplicity and clarity: CAGR offers the simplest, most straightforward measure of growth over time smoothing out volatility.
Comparability: It permits the comparison of rates of growth in different investments, companies or economic indicators, regardless of how volatile they are or the different periods of time they cover.
Decision Making: Decisions based on a consistent annual growth rate can make portfolio management easier for investors and benefit strategic corporate planning decisions.
Trend Analysis : When investing for the long term, it’s helpful to distinguish between trend and random volatility. CAGR helps answer the question: is this company’s growth sustainable over the long term?
There are multiple guidelines from financial regulatory bodies in India that endorse CAGR:
In India, the Securities and Exchange Board of India (SEBI) makes it mandatory for mutual fund performance reporting and other investment products to use CAGR to make sure investors make informed decisions.
Banking sector: The RBI (Reserve Bank of India) statistics: annual reports and publications use the concept of CAGR to show how the following parameters – credit growth and deposit growth – of the banking and financial sector grew over the period.
the Ministry of Corporate Affairs, or MCA: A company must report CAGR in its annual return. The company statement has to include growth in revenue and profit over a number of years.
These regulations help to guarantee that CAGR will be used correctly or, at the very least, consistently, and that it will at least show up in the financial reports that are sent out to investors and other stakeholders.
To illustrate the practical application of CAGR, consider the following example:
An investor invested ₹1,00,000 in a stock five years ago and today his shares are worth ₹2,00,000. What can be the Compound Annual Growth Rate \[ CAGR =\displaystyle{\left(\frac{E}{S}\right) }^\frac{1}{N}-1 \] of the rate at which shares grew per year (%)?
CAGR = (2,00,000 / 1,00,000) ^ (1 / 5) - 1
CAGR = (2) ^ 0.2 - 1
CAGR ≈ 0.1487 or 14.87%
This means that the investment has increased at a rate of 14.87% per annum in a period of five years.
To relieve our consciences, let us assume that we are in eighth grade. So why is it that, even today, long after Santa Claus and the train set, accepting this standby of the eighth grade continues to play a useful (some might say vital) role in one of the most market-capitalist countries in the world, Namely: India? CAGR is the standard method for assessing past performance of stocks, mutual funds, and other investment instruments by investors in India, and elsewhere around the globe. Not only that, but CAGR is a basic metric in corporate finance, economic analysis, and business and strategic planning.
for investment analysis: CAGR is used when investing globally to analyse the performance of portfolios in one or more countries, to analyse the performance of fund managers, and in investment allocation decisions.
Corporate Performance: CAGR allows multinational companies to produce revenues, profit margins and other stalwart indicators of their financial performance in percentage formats consistently, which can identify key signposts to investors and wider stakeholders about how their businesses have developed over time.
Economic Studies: Economists and policymakers use CAGR to track indicators measuring the economy, such as the GDP growth, the rates of inflation and of the trade balance as well as to provide comparison on these metrics between countries and to set policy.
For the benefit of all investors, analysts and policy-makers, CAGR is a measure that should be in everyone’s armoury. It is intuitive, transparent and granular. Its ability to measure growth over a period of time and inform policy and investment decisions is invaluable. CAGR’s vitality has received sustained regulatory support in India and it has become a common metric across all areas of corporate India (reflecting the depth and seriousness of the country’s financial literacy) with its common usage across all sectors of the economy. With the global economy deepening and expanding – in June, the World Bank put the figure at US$141 trillion, up 10 per cent on last year’s projection – CAGR is, and will remain, an important metric for all financial analysis and investment strategy.