The compound annual growth rate isn’t a true return rate, but rather a representational figure. It is essentially a number that describes the rate at which an investment would have grown if it had grown at the same rate every year and the profits were reinvested at the end of each year. For stock market investors, this can be particularly useful in comparing the performance of different stocks.
- To understand the idea of the compound annual growth rate, first of all, you should know what compound interest is.
- Suppose we are tasked with calculating the compound annual growth rate (CAGR) of a company’s revenue.
- Based on historical financial data, the CAGR of the investment is projected to be 3.0% across the next five years.
It also functions as a tool for comparing investments of different types. If you have investments in equities and other investments in accounts with fixed interest rates, the CAGR can smooth out stock volatility and create a more balanced view of both investments. Finally, about the stock market, you will notice that a high revenue CAGR or considerable EPS growth will make the stock price increase. However, you can even protect your gains by always investing in a stock that is over its 7-day moving average price. Anyway, the best is to invest in a stock that trades under its fair price, which can be calculated by the discounted cash flow model.
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Also, the CAGR does not account for when an investor adds funds to a portfolio or withdraws funds from the portfolio over the period being measured. This version of the CAGR formula is just a rearranged present value and future value equation. To ensure you understand the concept of CAGR, we have also computed the implied revenue to illustrate how CAGR can be used to forecast a company’s revenue, or “sanity check” the assumptions that underpin a projection model.
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On the other hand, the compound annual growth rate reflects the average rate of return that is required for an investment to grow from its initial balance to its final balance within a particular period on a yearly basis. In the case of CAGR, it doesn’t matter what the time horizon of the investment is. Note that, unlike the simple growth rate, the compound annual growth rate enables you to compare investments with different time horizons. As we have already explained in the introduction, CAGR is an acronym for compound annual growth rate. The formal definition of CAGR says that CAGR is the yearly rate of return that is required for an investment to grow from its initial balance to its final balance within a particular period. CAGR is counted with an assumption that profits are reinvested at the end of each year of its time horizon.
And the stock market’s overall trend has been upward with significant growth over time. At the end of the current period, the company has generated $100 million in revenue – and this figure is expected to grow at the following growth rates each year. Therefore, the CAGR effectively “smoothens” the growth rates for multiple periods into a single annualized growth rate. Conceptually, the CAGR metric measures the hypothetical growth rate, assuming that the percentage change occurred evenly at the same rate over each individual period, i.e. uniform timing. CAGR—or “Compound Annual Growth Rate”—is the annualized rate of growth in the value of an investment or financial metric over a stated period.
We can see that on an annual basis, the year-to-year growth rates of the investment portfolio were quite different as shown in the parentheses. For the sake of easy math, say you had an investment that grew 20 percent during the first year, but grew only 10 percent during the second year. Even though there was a 10-percent drop in growth during the second year, the average growth rate over the two-year term was 15 percent (the average of 10 and 20). For instance, if you held an investment for five years, the growth of that investment is likely to fluctuate from one year to the next. But for the sake of comparing that investment’s performance to other potential investments, it can be helpful to look at how much it grew each year, on average, during the entire five years.
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- There are no guarantees that working with an adviser will yield positive returns.
- Working with an adviser may come with potential downsides, such as payment of fees (which will reduce returns).
- This tool enables you to check how much time you need to double your investment even quicker than the compound interest rate calculator.
- Suppose there is a company with revenue of $20 million at the end of the current period (Year 0).
Many investors prefer the CAGR because it smooths out the volatile nature of year-by-year growth rates. For instance, even a highly profitable and successful company will likely have several years of poor performance during its life. These bad years could have a large effect on individual years’ growth rates but would have a relatively small impact on the company’s CAGR. The CAGR is a measurement used by investors to calculate the rate at which a quantity grew over time. The word “compound” denotes the fact that the CAGR takes into account the effects of compounding, or reinvestment, over time. For example, suppose you have a company with revenue that grew from $3 million to $30 million over a span of 10 years.
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The CAGR produces a geometric mean which can be used to compare different investment types with one another. For example, suppose that in 2015, an investor placed $10,000 into an account for five years with a fixed annual interest rate of 1% and another $10,000 into a stock mutual fund. The rate of return in the stock fund will be uneven over the next few years, so a comparison between the two investments would be difficult.
What is the compound interest?
To calculate the number of years, divide the total number of days by 365 (1,924/365), which equals 5.271 years. Year 0 is excluded when counting the number of periods, because only the periods when the revenue is compounding must be counted. Building on the above example, the CAGR correctly shows the ending value of the investment if a –3% CAGR was applied over a two-year compounding period.
One disadvantage of the Compound Annual Growth Rate is that it assumes growth to be constant throughout the investment’s time horizon. This smoothing mechanism may yield results that differ from the actual situation with a highly volatile investment. The formula can be used to calculate the overall performance of various investment avenues or financial instruments like bonds, stocks, projects, etc which involve returns for a number of years. It is a valuable tool for evaluating the growth or decline in investment valuation in order to make analysis and financial decisions.
What Is an Example of Compound Annual Growth Rate (CAGR)?
Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Both figures have their merits — but as this example shows, the two figures clearly are not interchangeable. The choice of CAGR vs AAGR depends on precisely what an investor is looking to measure.
How to Calculate Compound Annual Growth Rate (CAGR)
When evaluating long-term investment performance, the Compound Annual Growth Rate (CAGR) is essential for understanding growth trends over time. Traditional CAGR analysis, however, can miss critical insights and struggle with large or incomplete datasets. By harnessing the power of artificial intelligence, investors can streamline the process of analyzing extensive datasets, uncover hidden patterns, and create more accurate forecasts. The compound annual growth rate (CAGR) formula is the ending value divided by the beginning value, raised to one divided by the number of compounding periods, and subtracts by one. The CAGR is the rate of return of an investment—or a financial metric like revenue—across a predefined period, expressed in terms of an annual percentage.
Another tool that you can use to estimate the profitability of investment is our return on investment calculator. The CAGR formula gives an annualized rate of return, which is useful for comparing the performance of different investments over time. Use caution with time periods less than a year because in these cases the CAGR calculation may not be truly representative of long-term investment performance. CAGR is typically measured in years however you can use this CAGR Calculator to find the average rate of growth for other time periods.
Our CAGR Formula in Excel is based on the mathematical formula for CAGR. We’re using the end value — $300,000 — in cell B12; the beginning value — $100,000 — in cell B2; and the period of years — 10 — in cell A10. SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. Now that you know how to calculate CAGR, it’s high time you found other applications that will help you make the greatest profit from your investments.