Money invested in the stock markets is invested with the hope of return because that is something our capital employed can give us. Suppose if you invest Rs 100 today and receive Rs 112 at the end of one year, therefore your return is Rs 12, next year you again invest the same amount but this time the interest is Rs 50 and in the third year the return reaches to Rs 5. These are the irregular annual returns that are caused by the volatility and risk prevalent in the market. Now, this irregular return pattern might not be appealing to the investors so a more applicable method that is CAGR is used.
CAGR is not the growth rate but it is a respectable figure representing the annual growth over years. For e.g. When an investor has to invest, he has two options either to go for investment in stocks or investing in mutual funds. Now the investor will compare the CAGR of both and whose CAGR will be more that will be a better option for investment. CAGR is also used to track the strengths and weaknesses of many companies side by side. As a coin has two sides, same way CAGR has few limitations too. The drawback of CAGR is that it does not take into account the volatility and reflects that the growth has been steady and constant over years. The yearly growth rate and the CAGR will vary to a great extent.
One thing that I dislike about this is that when an investor injects or withdraws funds then it will increase or decrease the CAGR and solely contribute to the annual growth rate as the CAGR amount is calculated with the beginning and ending amounts so it is improper, but whenever the whole scenario is seen the power of Compounding is highly beneficial.