A good CAGR depends on the context. For stock market investments, a CAGR of 7-10% is generally considered strong, as it roughly matches the historical average return of the S&P 500. For individual companies, a revenue CAGR above 15-20% is considered high growth.

What is the difference between CAGR and average annual return?

A simple average return just averages each year's return, which can be misleading with volatile returns. CAGR uses the geometric mean, accounting for compounding, and gives you the single growth rate that would get you from the starting value to the ending value over the same period.

Can CAGR be negative?

Yes. CAGR is negative when the ending value is lower than the starting value, indicating that the investment or metric declined over the measured period.

What are the limitations of CAGR?

CAGR only considers the starting and ending values, ignoring volatility and interim cash flows. It assumes smooth growth, which may not reflect reality. It also cannot account for risk, making it important to use alongside other metrics like standard deviation or the Sharpe ratio.

Compound Annual Growth Rate (CAGR): Definition, Meaning & Examples

What is the Compound Annual Growth Rate (CAGR)?

The Compound Annual Growth Rate (CAGR) is a measure of a company, asset, or investment's performance expressed as an annualized percentage growth rate over a specified period.

By using the geometric mean rather than a simple arithmetic average, CAGR provides an average annual growth rate that smooths out the fluctuations of individual years. It tells you the single, steady rate at which an investment would have grown if it had grown at the same rate every year from the starting value to the ending value.

CAGR is widely used by investors and analysts to compare the performance of investments, evaluate company growth, and benchmark portfolios against indices like the S&P 500.

How to Calculate CAGR

The formula for Compound Annual Growth Rate is:

CAGR = \left(\frac{Ending\ Value}{Starting\ Value}\right)^{\frac{1}{N}} - 1

Where:

Ending Value = Value at the end of the period
Starting Value = Value at the beginning of the period
N = Number of years

Example of CAGR Calculation

Suppose a company had $100,000 in revenue in 2018 and $200,000 in revenue in 2022 (4 years later).

The CAGR for the four-year period would be:

CAGR = \left(\frac{200{,}000}{100{,}000}\right)^{\frac{1}{4}} - 1 = 2^{0.25} - 1 = 0.1892 = 18.92\%

This means the company's revenue grew at an average annual rate of 18.92% over the four-year period, even though the actual growth in individual years may have varied significantly.

When to Use CAGR

CAGR is a versatile metric with several practical applications:

Benchmark Investment Performance

CAGR gives a more accurate indication of true growth than simple averages because it accounts for the compounding effect. For example, if the S&P 500 has a 10-year CAGR of 8%, investors can compare their portfolio's CAGR against this benchmark to evaluate their relative performance. This is especially useful when comparing investments held over different time periods.

Compare Company Growth

CAGR is helpful for comparing the growth trajectories of different companies. You can calculate the CAGR of revenue, earnings, free cash flow, or dividends to understand which companies are growing faster. This is particularly valuable when analyzing companies in the same sector.

Evaluate Historical Performance

CAGR allows investors to measure the success of a given investment or business initiative over a specific period. By smoothing out annual fluctuations, it provides a clearer picture of long-term trends than looking at individual yearly returns.

Compare Industries and Asset Classes

When analyzing different industries or asset classes, CAGR is a useful way to make objective comparisons and determine which investments are most likely to produce profitable results over the long run.

CAGR vs. Internal Rate of Return (IRR)

While both CAGR and the Internal Rate of Return (IRR) are used to evaluate investment performance, they serve different purposes:

Feature	CAGR	IRR
Inputs	Starting value and ending value only	All cash flows (timing and amount)
Cash flows	Ignores interim cash flows	Accounts for all interim cash flows
Reinvestment	Does not assume reinvestment	Assumes cash flows are reinvested at the IRR
Best for	Simple point-to-point growth comparison	Evaluating investments with multiple cash flows
Complexity	Simple to calculate	Requires iterative calculation

CAGR is better for straightforward comparisons of overall growth, while IRR is more appropriate for investments with irregular cash flows, such as private equity or real estate projects.

CAGR vs. Average Annual Return

Consider an investment that returns +50% in Year 1 and -50% in Year 2:

Simple average return:

\frac{50\% + (-50\%)}{2} = 0\%

This suggests no loss — but that's misleading.

CAGR:

\left(\frac{\$75}{\$100}\right)^{\frac{1}{2}} - 1 = -13.4\%

This reveals the actual loss.

This demonstrates why CAGR is a more accurate measure of investment performance than a simple average. It reflects the actual ending value of the investment.

Limitations of CAGR

While CAGR is a valuable metric, it has important limitations:

Ignores volatility — CAGR assumes smooth growth and does not capture the ups and downs experienced along the way. Two investments with the same CAGR can have very different risk profiles.
No interim cash flows — CAGR does not account for dividends, additional investments, or withdrawals during the period.
Point-to-point measurement — The result is sensitive to the specific start and end dates chosen. Cherry-picking dates can make performance look better or worse than it actually was.
No risk adjustment — CAGR does not account for the risk taken to achieve the return. Metrics like return on invested capital or the Sharpe ratio should be used alongside CAGR for a more complete picture.

The Bottom Line

The Compound Annual Growth Rate is one of the most widely used and intuitive metrics for evaluating investment and business performance over time. It smooths out annual volatility to provide a clear picture of average annual growth, making it invaluable for benchmarking, comparing investments, and analyzing company fundamentals. However, investors should always use CAGR in combination with other metrics like IRR, ROI, and risk measures to make well-informed investment decisions.

Compound Annual Growth Rate (CAGR)

Frequently Asked Questions