What Is a Compound Annual Growth Rate (CAGR)?

What Is a Compound Annual Growth Rate (CAGR)?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A Compound Annual Growth Rate (CAGR) is a measure used in finance that depicts the rate at which an investment would have grown if it had increased at the same rate annually. The assumption is that the profits were reinvested at the end of each year. It is used to compare the annual growth rates over a period across different investments. The CAGR isn’t the actual return rate but rather a representation of the rate at which an investment would have grown if it had grown at a steady rate.

Related Questions

1. How is CAGR calculated?

CAGR is calculated using the formula:
CAGR = (Ending Value / Beginning Value) ^ (1/n) – 1
Ending Value = the final value of the investment,
Beginning Value = the initial value of the investment, and
n = number of years

2. What distinguishes CAGR from other growth measures?

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CAGR smoothens the return rate of an investment by considering the period of investment, unlike other growth rates that are uneven and volatile. It simplifies analysis and comparison of different investments over time.

3. When is it appropriate to use CAGR?

CAGR is particularly useful when comparing the growth rates of investments over a long period. It’s also used in forecasting future growth, understanding a company’s financial performance, or analyzing investment returns.

4. What are the limitations of CAGR?

CAGR doesn’t consider the risk or volatility of returns during the investment period. It also assumes that profits are reinvested, which doesn’t happen in all cases. Lastly, because it’s an average, it can oversimplify outcomes for investments that have fluctuated greatly from year to year.

5. Can CAGR be negative?

Yes, CAGR can be negative. A negative CAGR indicates that the value of the investment or revenue has decreased over the years rather than increased.