Compound annual growth rate (CAGR) is the average annual growth rate in the price of a stock or a commodity over a specified period longer than one year.
This article covers the definition and uses of CAGR. To calculate CAGR effortlessly you can use our online CAGR calculator tool.
Why calculate CAGR?
When we invest in fixed income deposit scheme in banks, we earn fixed amount of interest compounded annually to our principal, but prices of stocks and commodities fluctuate on a daily basis. Compund Annual Growth Rate evens out the fluctuation and gives a representational number to show how much the investment would’ve grown if it were to grow steadily. Compound Annual Growth Rate can make it easy to compare the rate of returns of different stocks or commodities. It can also help with the comparison of returns between different asset classes.
Formula for finding CAGR:
Let’s try to understand Compound Annual Growth Rate through an example:
Suppose you bought a share of a company for Rs. 100 on 1st January, 2008. A year later the value decreased to Rs. 60. Next year it rose to Rs. 120 and so on. Several years and fluctuations later, in 2018 you sold the share at Rs. 1000.
Final value is 1000, initial value is 100 and number of years is 10 years. Putting these numbers in the formula we get:
CAGR = ((1000/100)(1/10)-1)*100 = 25.89 %
This stock would give you 25.89% interest per year, against the 7-8% interest (Indian rates) of a fixed deposit account.
So, if you have to compare the returns of this investment with fixed deposit interest rates, you can easily do that.
Notice of caution:
Compund Annual Growth Rate is a metric used to derive the steady representational returns of an unsteady stock or commodity. As such, it works on past data and shows past data. This data alone should not be considered for calculation of future returns. Future returns depend on the company’s future growth. Usually if the income of a company grows by, say CAGR 20%, its stock price would also grow by CAGR 20%.