Real meaning of CAGR | Compounding DOES NOT EXIST in Stock Market - YouTube

Hey Guys! Welcome back to the channel This is money-minded Mandeep

And something is definitely different I thought for a while that

Can I make this 10-15 minutes video standing in this awkward position

So that you can't see my hairstyle [Just Kidding]

After my last haircut, My hairstyle was beautiful as always

Then I thought let's try new look by removing all the hairs

I thought that I will look cool

but all friend's and family member's response was negative

But no issue, let's come to the point

Today's video is about the CAGR

Do you need to watch the entire video or you already know about it

It depends on a small question

let's say you bought a share worth ₹900 in 2015

The price of that share was ₹1300 in 2016

And its value was ₹1000 in 2017 Now please tell me that

How much return did you earn on your investment?

If you see the ₹100 profit on your ₹900 investment

And you think that I earned around 11% return then this is the wrong method

So, you need to watch this complete video to understand CAGR

But if your answer was 5.4% then probably this video is not so important for you

You can save your time and can watch something else

You may know something new if you already know the concepts

You will understand what is CAGR and why this is important

You should know that how to calculate it and what is the best way to calculate it

No, that is not pen and paper That is also not Excel Sheet

I will tell you an easy way in which you don't need to apply any formula

You will learn to calculate it directly without any formula

If you are one of those people who watch the Youtube videos

But don't implement that knowledge in real life the I request you that

If you don't learn it today then you will lose a lot of money and time

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Let's understand the concept using the old same example

The value of that share was 900 in 2015, 1300 in 2016, and 1000 in 2017

Some people may think that this is ₹100 profit on ₹900 investment

So, this is an 11% return. But this is the absolute return.

The absolute return depends on your first value and the last value

And it indicates the percentage change between them

Its drawback is that it doesn't consider time. It wouldn't tell you that

This 11% return has been generated in the 2 years or in 10 years

That is very important. Many insurance agents can manipulate you like this

They will say you to invest a lumpsum amount and you will get its double on maturity

The amount will be double that is good.

But we forget to ask that how many years will it take

Maybe your money will be doubled after 20 years

There may be some instruments that can double your amount in 15 or 10 or 8 years

It is not a right question - which investment is doubling our money in minimum time

Right question is that how much annual return we can expect in this particular investment

Or what returns this particular investment has generated in the past

Let's know that what is CAGR

Let's learn with the old example and expand it

Let's say that share's value was ₹900 in 2015, ₹1300 in 2016, ₹1000 in 2017

₹1200 in 2018, ₹1600 in 2019, ₹1500 in 2020 and finally ₹2000 in 2021

So, how to know that what annual yearly returns this investment has generated

Because the price is going up and down. If we denote it in percentages

There was a 44% growth in 2016 and it was -23% in 2017 (Decrement)

It gained by 20% in 2018 and 33% in 2019 and decreased by 6.5% in 2020

Finally, there was a 33% growth in 2021. Still, there is a confusion

As sometimes it is increasing by 44% and sometimes decreasing by 23%

We want to know this stock's average annual returns in the last 6 years

We have to calculate CAGR. CAGR means such a percentage rate

On which if I put this ₹900 for the next 6 years then I will get ₹2000 at the end

During this period, if the share increases by 44% or decrease by 23%

But still, if the share is hitting till ₹2000 in the 6 years

Then by what rate that investment is increasing annually

Let's understand it in another way. Suppose I put ₹900 in the bank

And if that amount becomes ₹2000 in the 6 years then what is the growth rate?

So, the CAGR is nothing but compound interest which we studied in 10th class

Its formula is FINAL VALUE = PREVIOUS VALUE * (1+r/100) raised to the power n

The final value is ₹2000 and the the previous value is ₹900 in our case

r means CAGR which we want to calculate and n is the number of years

Let's enter the values of our example in this formula -

2000=900*(1+r/100) raised to the power 6

Many people do a big mistake when calculating the CAGR

They will do the mistake while calculating the number of years

Here from 2015 to 2021, we have 7 data points

But the number of years is 6 in this case because

The ₹900 of 2015 will take 1 year to hit 1300 in the year 2016

So, from 2015 to 2016, it is 1 year from 2016 to 2017, 1 another year

from 2017 to 2018, 3rd year, and so on

So, the number of years here is not 7 but it is 6

So, enter the number of years correctly while calculating the CAGR in the future

In this formula, we have to solve for r and I will not solve it completely

Let's know the direct formula to calculate the compound interest

You don't need to solve this because we have another way to solve it

Visit the link labourlawadvisor.in/calculators Link is also given in the description

You have to enter 3 values there

Your initial value (₹900 in our case)

Your Final Value (₹2000 in our case)

No of years (6 in our case)

When you enter these values

You will get the result 14.23%

After calculating the CAGR, you can decide that is this investment good or not?

If this is an equity investment and giving 14.23% return then this is amazing

If this is a cryptocurrencies data in which you expect a multi-bagger return

Then maybe this return is not good but that depends on your expectation

Now, this is very easy for you to identify a good or bad investment

Because your wealth is growing by annual average 14.23% return

You can treat it as standalone. If this is an equity investment

And you are happy with 14.23% return then this is good

You can also compare different investment instruments using the CAGR

Maybe you have 5 mutual funds and you want to identify 1 with the best CAGR

Apart from investment, this can be used in various situations

Suppose you want to do the fundamental analysis of any company

And these numbers are not shared price but these are profit figures from 2015 to 2021

The company profit is fluctuating in the different years

But you want to know the annual average growth rate. Then using the CAGR

You can say that the company profit has grown 44.23% average annual rate in the last 6 years

When your agent wants to sell you his policy, then using this CAGR

You can calculate the annual average growth rate of your investment amount

But there are some drawbacks of CAGR

Have a look at this example

The time is same but values are changed

Share price was ₹900 in 2015 and ₹1 in 2016

It is ₹1000 in 2017 and ₹10,000 in 2018

It is again only ₹2 in the next year

Then ₹50,000 and then ₹2000

It means this share is highly volatile

You can lose your entire money

When we calculate its CAGR, Final value is ₹2000 and the Initial value is ₹900

The number of years is 6

Then the CAGR is the same 14.23%

Suppose I remove the data of 2020 and 2021

Now, the initial value is ₹900, and the final value is ₹2

The number of years is 4

Then the CAGR is -78.23%

So, CAGR has 2 drawbacks First, it doesn't tell you the volatility

Like how much the price of our security fluctuate

And how much risk is associated. CAGR can't convey this

It will only indicate the annual average growth rate of a certain period

Its 2nd drawback is period. If you change the period

As I did earlier when I replaced 6 by 4

Then +44.23% changed to -78.29%

That's why it is said that compounding doesn't exist in the stock market

Because compound interest is necessary for compounding

The interest means your money will grow with a certain percentage always

And you will get interest next year on your principal amount and interest both

But as we know, this doesn't happen in the stock market and mutual funds

But still, we can be wealthy by investing in the stock market

And the graph doesn't grow in a straight line

It fluctuates up and down many times.

And finally, it created wealth for us.

But the mathematical concept behind that is not the power of compounding

Because if you vary your period by 1 or 2 year

Then you will get a different CAGR in each case.

While calculating the returns in the stock market and mutual funds

We use CAGR so that we can see annual returns over the period of time

If we can't calculate the annualized return of an instrument then

How will we compare it with FDs etc to know that is it better than that or not

Then we will be able to decide that should we take extra risk

And should we invest in that instrument or not?

So, CAGR is only used to calculate annualized annual returns

When it comes to the stock market and mutual fund

But compound interest itself doesn't exist in the stock market and mutual funds

But you can still use CAGR as it is reliable in many cases

Suppose you are investing for the last 10 years And you want to calculate

The average annual growth rate of your investment then this is a good matric

Or suppose you have companies' data like profit data, sales data

And you want to calculate the best CAGR among all 3 companies

And you want to invest in that company Then again this is a good matric

Or you can also compare differently investment instruments using this

If any agents try to convince you to invest in his policy

Then, first of all, you should check its CAGR. If it is like around 5-6%

Then you can compare it with other investment options like FD

If you are getting 5% in FD without lock-in then you can go with FD

Or you can easily find the investment options with the better return like PPF

Or you can earn around 8-8.5% in safe government bonds or PSU bonds

So CAGR allows you to compare different investment options

But it fails while calculating the returns of SIP

Suppose you want to continue a SIP for 10 years

The money you invested on the 1st day of 1st month of 1st year, that

Will be invested for 10 years And the money which you invested

On the 1st day of 2nd month of 1st year, that will be invested for 9 years and 11 months

And your next SIP amount will be invested for 9 years and 10 months

And the money which you invested in 11th month of last year

That amount will be invested for only 2 months.

Thus you have to calculate CAGR for 120 times as you invested 120 times

Then still you will be not able to figure out the average annual return on your SIP

We use another method for that.

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