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What is CAGR?
CAGR (Compound Annual Growth Rate) measures the mean annual growth rate of an investment, business metric, or financial variable over a specified period longer than one year, assuming profits are reinvested and growth occurs at a steady compounded rate.
Definition
The Compound Annual Growth Rate (CAGR) is the rate at which an investment would have grown if it had increased at a fixed percentage each year on a compounded basis.
Key Takeaways
- CAGR smooths out volatility to show the true annual growth rate over time.
- It is widely used in investing, corporate finance, valuations, and performance benchmarking.
- CAGR assumes reinvestment of returns, making it more accurate than simple average growth rates.
- It helps compare the performance of different investments or business units.
Understanding CAGR
CAGR is one of the most important financial metrics for evaluating performance over time because real-world financial data rarely grows in a straight line. Revenues, stock prices, and investment values fluctuate from year to year, making simple averages misleading. CAGR solves this by showing what the yearly return would have been if growth had occurred at a stable, compounded rate.
Businesses use CAGR to evaluate multi-year revenue growth, customer base expansion, and product performance. Investors use it to compare the long‑term performance of stocks, index funds, or portfolios. It is also central to valuations, financial modelling, and strategic planning.
CAGR does not show volatility or risk, but it provides a clean, comparable metric that simplifies long‑term performance analysis.
Formula
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1
Real-World Example
A private equity firm acquires a company for $20 million and sells it five years later for $38 million. The CAGR is:
CAGR = (38 / 20)^(1/5) – 1
CAGR ≈ 13.9%
This means the company grew at an implied rate of 13.9% per year, even if actual yearly performance varied.
Importance in Business or Economics
CAGR is widely used in:
- Investment analysis: Comparing long‑term returns across asset classes.
- Corporate strategy: Benchmarking revenue, profit, or customer growth.
- Valuation: Supporting projections in DCF models and investor presentations.
- Financial reporting: Showing long‑term performance in a simple, credible way.
Understanding CAGR helps leaders make informed decisions and evaluate whether performance aligns with strategic objectives.
Types or Variations
- Revenue CAGR: Used in valuations to measure company growth.
- Customer CAGR: Tracks user or customer adoption over time.
- Portfolio CAGR: Evaluates long‑term investment returns.
- Market CAGR: Measures industry or sector growth.
Related Terms
- Annual Growth Rate
- IRR (Internal Rate of Return)
- ROI (Return on Investment)
- NPV (Net Present Value)
- Forecasting Models
Sources and Further Reading
- Investopedia – Compound Annual Growth Rate: https://www.investopedia.com/terms/c/cagr.asp
- CFA Institute – Investment Foundations (CAGR section): https://www.cfainstitute.org/en/programs/investment-foundations
- McKinsey – Corporate Finance Insights (Growth metrics overview): https://www.mckinsey.com/capabilities/strategy-and-corporate-finance
Quick Reference
- Formula: (EV / BV)^(1/n) – 1
- Best Use: Multi-year growth comparisons
- Assumption: Constant compounded growth
FAQs
Is CAGR the same as annual return?
No. Annual return measures one year; CAGR measures multi‑year compounded returns.
Does CAGR show volatility?
No. It smooths volatility and cannot reflect risk or fluctuations.
Why do investors prefer CAGR?
It gives a clean, comparable measure of long‑term performance.
