Definition – What is “CAGR” (or Compound Annual Growth Rate)?
CAGR is the rate of return an investment needs to reach a target amount.
The result is smoothed out over the years. A company with a CAGR of 7% over 5 years may have had:
- A 7% growth rate in each of those years
- A growth rate of 40% in the first year followed by near-0% growth in the remaining 4 years.
- A growth rate of -50% in the first year followed by a CAGR of 41.42% over the remaining 4 years.
- Any combination of growth within each of those years that resulted in a smoothed out 7% over 5 years.
When is CAGR used?
CAGR is found in the financial industry, primarily to gauge returns of companies or investment/mutual funds.
It is helpful to analyze and compare the return of financial instruments.
Formula – How to calculate CAGR
CAGR = (Ending Balance ÷ Beginning Balance)1÷Number of Years– 1
To find CAGR:
- Divide the value and the beginning of the period by the value at the end of the period.
- Take that result and raise it to the exponent of (1/number of years).
- Subtract 1 from the result.
- Your result will be a decimal value which can be converted to a percentage.
An investment has a starting balance of $10,000 with an ending balance of $20,000 in 5 years.
CAGR = (20,000 ÷ 10,000)1÷5 – 1
CAGR = 20.2 – 1
CAGR = 1.148698 – 1
CAGR = 0.1487
Therefore, the compound annual growth rate is 0.1487, or 14.87%.