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What is CAGR? Description
Compound Annual Growth Rate is the average annual growth rate of an investment
over a specified period of time.
Calculation of Compound Annual Growth Rate. Formula
CAGR is calculated by taking the Nth root of the total percentage growth
rate where N is the Number of Years in the period being considered.
CAGR = ( ( End Value / Begin Value )(1 / N ) ) - 1
Usage of CAGR. Applications
- Calculating and communicating the average returns of investment funds.
- Demonstrating and comparing the performance of investment advisors.
- Compare the historical returns of stocks with Bonds or with a savings
account.
Strengths of CAGR. Benefits
- It is a useful formula to evaluate how various investments or a portfolio
has performed over time.
- Can be used for comparing and for evaluating the performance of one
stock against other stocks in a peer group or against a market index.
Limitations of CAGR. Disadvantages
- CAGR assumes that an investment grew at a steady rate. In reality there
is volatility: investment results can vary significantly over time. This
volatility, or investment risk, is important to consider when one makes
an investment decision.
- CAGR is a historical measure. Historical results are not always a reliable
indicator of expected returns in the future.
- CAGR is sensitive to the period which you consider and it can be easily
manipulated: an investment fund may tell you that it achieved an impressive
CAGR of 35% over the last three years, but the Begin Value may be taken
at a the lowest point that the fund ever had.
Assumptions of Compound Annual Growth Rate. Conditions
- CAGR assumes that an investment grows at a steady pace. This is normally
not the reality. Therefore CAGR is an imaginary conception. It describes
the growth of an investment as though it had grown at a steady pace.
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Pankaj - Nepal
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CAGR |
"If net profit for year 2000 is -ve 200million and for year 2004 is 400million, then what will be the CAGR?" |
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