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Saturday, 18 November 2017

Compounded Annual Growth Rate - CAGR

Ever come Across Following Phrases?
- Our Company has given 33% CAGR Returns in last 30 Years.
- If you had invested in our Mutual Fund Rs One Lakh in 2000, you would have 22 Lakh in 2017 - A Mind Boggling 20% CAGR in last 17 years
- This Company can Grow at 66% CAGR for next 10 years

And they follow this with Disclaimer - Read Offer Document Carefully before investing :-)

What is CAGR Really? Are these Statements Really as Awesome as they Sound? Read on...

Welcome to the Roaring Bull Market Friends.


Dearest investors & friends,


How are you all doing? As I write this Article, The Overall Markets are doing exceptionally well. The Nifty is above 26 times Trailing Earnings. We are at a phase where Most Businesses and Mutual Funds are Boasting about their CAGR Returns :-) 


CAGR is the Most Used, Abused and Misused word in the Market Today.

Today, I am going to deep dive into what CAGR really means. What is Compounded Annual Growth Rate? How does it Work? Whom does it Really Benefit?




When we invest in a Fixed Deposit, we get Fixed Returns every Year. For eg: A Fixed Deposit would give us around 6% Compounded Annual Returns Every Year.

What this means is, if we invest Rs 500 in the year 2000 in the 6% CAGR FD for a period of 17 years, we would have Rs 1346 at the end of the period.




What if we invest in an instrument which gives us 20% returns every year. Fixed Returns. There is no such instrument but, just hypothetically.


Chart would look like this. In 17 years, we would end up with Rs 11093 in year 2017 on a Rs 500 investment in year 2000.




But, friends. In Equity Based Investments, the Returns are NOT FIXED every Year. Chart is not like the above. 


Let's begin by Looking at Price Chart of 3 companies over 17 years (2000 - 2017):


Let's Assume that all 3 Companies have given 20% CAGR over 17 years (Since they began with Rs 500 in year 2000 and ended with Rs 11000 in year 2017)






Company 1 has had a pretty steady graph. So a person who entered in year 2000 would get 20% CAGR over 17 years, provided he/she stayed invested. 





Company 2 has a very interesting Graph. If you notice, the person who invested Rs 500 in year 2000 was at Rs 1200 in year 2002. But until year 2013, the investment remained in the range of Rs 800 to Rs 1200. Yes, 11 years of no movement. But, from year 2013 to 2017, the movement was very very quick. It moved from Rs 1000 to Rs 11000 in a matter of 4 years. So even in this investment, the person who stayed for 17 years enjoyed CAGR of 20% (even though the maximum returns came in the last 4 years). But, if we calculate CAGR from year 2013 to 2017, it is a Mind Boggling 81%. 



Company 3 has a very Cyclical Graph. Investment moved from Rs 500 to Rs 10000 and then back to Rs 1500 to Rs 12000 and then at Rs 11000 in year 2017. Even in this case, the CAGR would be 20% for a Period of 17 years. But, people who invested in between either lost their money or Made Returns. The Time Spent and the Timing of the Investment made the Difference.


I hope you have got a Good Feel of what CAGR really is. So let me summarize this for all readers:


- The Most Important Thing to Note is that Compounded Annual Growth Rate in Equity Market is Not Fixed Yearly Returns.

- If someone claims that Company has Grown at 20% CAGR for last 17 years, this is Applicable only and only for People who stayed invested for 17 years. There might have been multiple Ups and Downs in the 17 years.
- CAGR would change based on when Entry and Exit in Equity Market Investment
- CAGR over a Longer Period of Time is Important for Investors
- An Excellent CAGR over Short Period of Time might lessen as Time Progresses

So, next Time any Mutual fund or Promoter talks about CAGR, you should read between the Lines. Especially in a Roaring Bull Market, Tall CAGR Claims are made. 

When we Invest in the Stock Market, we need to always Remember that in Quality Businesses which are Growing their Revenues & Profits at 20% plus every year, the Stock Price will also Compound Well over a Period of Time.


So, let us Continue to Focus on Businesses which would Compound its Business and if that happens, we can get good CAGR Returns over a Good Number of Years.


Click here to Take a Quick Quiz on CAGR


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Good luck,
Fundamental Investor

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Our aim should be to learn and share the art of investing in the Indian Stock market. With right perspective, understanding of stock market basics and a sound attitude, we can all identify Multibaggers and evolve towards Wealth Creation. Are you ready to own businesses? Welcome aboard !!! Lets learn, serve and grow together !!! 
- FI