CAGR (Compound Annual Growth Rate) is the steady annual rate at which a value would have grown to reach its end figure, smoothing out year-to-year ups and downs. Formula: (Ending Value ÷ Beginning Value)^(1/n) − 1, where n is the number of years.
What Is CAGR?
The Formula for CAGR
CAGR = (Ending Value ÷ Beginning Value)^(1/n) − 1n = number of years
Where:
- Ending Value: The final value of the investment or metric.
- Beginning Value: The initial value of the investment or metric.
- n: The number of years.
Example Calculation
Imagine you invested $10,000 in a stock, and after 5 years, it’s worth $16,105.
Calculation:
CAGR = ($16,105 ÷ $10,000)^(1/5) − 1 = 10%
This means your investment grew at an average rate of 10% per year over those 5 years.
Why Does CAGR Matter?
CAGR is an important metric for several reasons:
- It smooths out volatility: Real growth is often uneven, but CAGR gives you a steady rate.
- It allows for easy comparison: You can compare investments with different time frames.
- It accounts for compounding: Unlike simple averages, CAGR considers the effects of compounding.
- It’s widely used: From stock returns to GDP growth, CAGR is a common metric in finance.
Applications of CAGR
CAGR is used in various contexts, including:
- Investment Returns: Measure the performance of stocks, bonds, or portfolios.
- Revenue Growth: Track business growth over time.
- Market Size Projections: Forecast industry or market growth.
- Population Growth: Analyze demographic trends.
Limitations of CAGR
While useful, CAGR has some limitations:
- Assumes steady growth: Real growth is often uneven.
- Doesn’t show volatility or risk: It provides a smooth rate but omits ups and downs.
- Can be misleading: If the start or end point is unusual, CAGR might not reflect typical performance.
CAGR vs. Simple Average
Here’s an example to illustrate why CAGR can be more useful than a simple average:
Investment A:
- Year 1: 20% growth
- Year 2: -10% growth
- Year 3: 40% growth
Investment B: Steady 15% growth each year
Simple Average Growth: Both investments have the same simple average growth of 16.67%, but their CAGRs differ:
- Investment A CAGR: 14.87%
- Investment B CAGR: 15%
CAGR reveals that despite the volatility, Investment A actually performed slightly worse overall.
CAGR FAQ
How do you calculate CAGR?
Divide the ending value by the beginning value, raise the result to the power of 1 divided by the number of years, then subtract 1: CAGR = (End ÷ Start)^(1/n) − 1. Growing $10,000 to $16,105 over 5 years gives a 10% CAGR. Use the calculator above to run your own numbers.
What does CAGR mean?
CAGR (Compound Annual Growth Rate) is the constant yearly rate that would take a value from its starting point to its ending point over a set period, as if it grew smoothly each year. It accounts for compounding, unlike a simple average.
What is the difference between CAGR and average growth rate?
A simple average just adds yearly growth rates and divides; it ignores compounding and can overstate performance. CAGR reflects the actual compounded result. Two investments can share the same simple average but have different CAGRs, the more volatile one usually has the lower CAGR.
Related growth-rate metrics
- Revenue Growth Rate, the headline period-over-period revenue metric, start here.
- Month-over-Month (MoM) Growth Rate, short-term, month-level momentum.
- Compounded Monthly Growth Rate (CMGR), smoothed average monthly growth across a span.
- CAGR (Compound Annual Growth Rate), compound growth across multiple years. (you are here)
- Customer Growth Rate, growth in customer count, not revenue.
