This video by Edelweiss Wealth Managements talks about what Compound Annual Growth Rate (CAGR) is, how to calculate CAGR and why it is important to know this parameter.
What is CAGR (Compound Annual Growth Rate)?
CAGR or Compound Annual Growth Rate is the annual rate which tells us how the company has grown in the past few years and how it is expected to grow. This parameter is helpful in evaluating the performance of a company. CAGR is helpful when the investor wants to know what the revenue trajectory has been during the entire course of his investment.
How to calculate CAGR?
Given below is the CAGR formula:
((Ending Value of Investment/Beginning Value of Investment)^(1/Number of Years of investment)) – 1
It is also important to know that CAGR is represented in the form of percentage. While the compound annual growth rate helps you understand the trends of the company better, it is always important to know that while CAGR shows geometric representation of your investment, it is merely a representational figure. Also it completely ignores market volatility and can often camouflage the year on year growth patterns.
Advantages of CAGR
1. The CAGR formula is useful for evaluating how different investments have performed over time.
2. Investors can use CAGR as a comparison to parameter to decide how one stock has performed in comparison to the others in any group or in a particular market index.
3. You can also compare the historical returns of stocks to that of a savings account or a bond.
Risk associated with CAGR
1. Market volatility is an aspect that always needs to be taken into consideration while making an investment. CAGR does not take market volatility into consideration, hence it is should not be the only parameter to be considered by making an investment.
Hence, it is important to recognize that while CAGR helps analyse the performance of a company before investing in it’s stock, this should not be the sole parameter to consider. A few other parameters like standard deviation, dividend yield, etc. also need to be considered before investing you hard earned money.