The Compound Annual Growth Rate (CAGR) is one of the most widely used metrics to measure the growth of an investment or business performance over a specific period. It represents the rate of return that would be required for an investment to grow from its beginning balance to its ending balance, assuming the profits are reinvested at the end of each period.

Understanding CAGR is essential for investors, business owners, and analysts to gauge the long-term performance of an asset or company.

In this guide, we’ll explain what CAGR is, how to calculate it, and provide practical examples to help you understand the formula and its applications.

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What is CAGR?

The Compound Annual Growth Rate (CAGR) measures the mean annual growth rate of an investment over a specified period of time longer than one year. It’s a useful way to compare the performance of different investments or companies and determine their growth rates in a standardized way.

Formula for CAGR

The formula for calculating CAGR is:

CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1

Where:

• Ending Value is the value at the end of the investment period (final amount).
• Beginning Value is the value at the start of the investment period (initial amount).
• Number of Years is the number of years the investment or growth is measured over.

Why Use CAGR?

CAGR is helpful because it smooths out fluctuations in growth, offering a constant growth rate over time. It’s often preferred over simple averages, as it eliminates the effect of volatility and gives a more accurate picture of an investment’s or company’s overall growth trend.

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How to Calculate CAGR

Step-by-Step Calculation

1. Identify the Beginning and Ending Values
   You will need the initial value (Beginning Value) and the final value (Ending Value) of the investment or business over the specified time period.
2. Determine the Time Period
   The time period is typically expressed in years, but it can also be in months, quarters, etc. Ensure you have the number of years for your calculation.
3. Apply the CAGR Formula
   Use the formula to calculate the compound annual growth rate over the time period.
4. Interpret the Result
   The result will give you the average annual growth rate over the period in percentage terms.

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Example Calculations

Example 1: Investment Growth Calculation

Let’s say you invested $1,000 in a stock, and after 5 years, the value of your investment grew to $2,500.

1. Beginning Value = $1,000
2. Ending Value = $2,500
3. Number of Years = 5

CAGR = (2,500 / 1,000)^(1 / 5) – 1
CAGR = (2.5)^(0.2) – 1
CAGR ≈ 0.2002 or 20.02%

So, your investment has grown at a compound annual growth rate of 20.02% per year over the last 5 years.

Example 2: Business Revenue Growth

Suppose a company’s revenue was $2 million in 2015 and grew to $4 million in 2020. You want to calculate the CAGR of the company’s revenue over 5 years.

1. Beginning Value = $2,000,000
2. Ending Value = $4,000,000
3. Number of Years = 5

CAGR = (4,000,000 / 2,000,000)^(1 / 5) – 1
CAGR = (2)^(0.2) – 1
CAGR ≈ 0.1487 or 14.87%

The company’s revenue grew at a 14.87% CAGR over the 5-year period.

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Practical Applications of CAGR

1. Investment Analysis
   Investors often use CAGR to evaluate the long-term performance of an investment portfolio, stock, or mutual fund.
2. Business Performance
   Companies use CAGR to measure the growth of revenues, profits, or other key financial metrics over time, helping them set future goals.
3. Market Comparison
   CAGR is used to compare growth rates between different companies, sectors, or even entire economies over the same time period.
4. Forecasting
   CAGR can be used as a forecasting tool to predict future growth based on historical data, though it assumes that growth will continue at a constant rate.

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CAGR vs. Average Annual Growth Rate (AAGR)

While CAGR gives you the smoothed annual growth rate, the Average Annual Growth Rate (AAGR) is a simple arithmetic mean of yearly growth rates over a period. AAGR doesn’t account for the compound effect of reinvested gains or losses, so it can often overstate or understate the true growth.

• CAGR assumes the growth rate is compounded annually.
• AAGR is simply the arithmetic average of annual growth rates.

CAGR is typically more accurate for measuring long-term growth and future projections, as it accounts for compounding.

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CAGR Calculator Example

You can use the CAGR Calculator below to quickly calculate the Compound Annual Growth Rate for your investment or business data:

Beginning Value	Ending Value	Number of Years	CAGR (%)
$1,000	$2,500	5	20.02%
$2,000,000	$4,000,000	5	14.87%
€50,000	€100,000	10	7.18%

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Frequently Asked Questions (FAQs)

1. What is the significance of CAGR?

• CAGR gives you a smoothed average rate of growth, which is useful for understanding long-term trends. It helps investors and businesses compare growth rates between different investments or companies and evaluate their financial performance over time.

2. Can CAGR be negative?

• Yes, CAGR can be negative if the ending value is lower than the beginning value. This indicates a loss over the period. For example, if an investment dropped from $1,000 to $500 over 3 years, the CAGR would be negative.

3. Is CAGR the same as Return on Investment (ROI)?

• No, CAGR measures the annualized rate of return over time, while ROI simply calculates the total return over a period, without considering the compounding effect. CAGR provides a more accurate picture of growth over multiple periods.

4. Can CAGR be used to predict future growth?

• CAGR assumes that growth will continue at the same rate over time. While it can provide insight into historical performance, using CAGR to predict future growth should be done cautiously, as future growth rates may vary.

5. What if my data includes irregular time periods (months or quarters)?

• If your data includes periods shorter than a year, you can still calculate CAGR, but you will need to adjust the time period accordingly. For example, for quarterly data, divide the number of months by 12 to express it in years.