What is Compound Annual Growth Rate (CAGR)?

Full Definition

Compound Annual Growth Rate (CAGR) is a single figure representing the constant, smoothed annual rate of return that would be needed to grow an investment from its starting value to its ending value over a stated number of years, calculated as (ending value divided by starting value) raised to the power of one divided by the number of years, minus one. CAGR is widely used to compare the performance of different investments, funds or business metrics (such as revenue growth) over the same time period on a like-for-like basis, because it strips out the actual year-to-year volatility of the real returns and reduces them to a single, easily comparable average annual figure. The key limitation of CAGR is precisely that smoothing effect: two investments can have the identical CAGR over five years while having taken very different paths to get there -- one might have grown steadily each year, while the other might have suffered a large loss followed by a large recovery -- so CAGR alone does not reveal anything about the volatility, drawdowns, or risk an investor actually experienced along the way. Because CAGR only considers the starting and ending values, it can also be distorted by the specific start and end dates chosen for the calculation -- picking a start date at a market low point, or an end date at a market peak, can produce a CAGR figure that flatters the underlying investment's typical performance, which is why analysts often check CAGR over several different, overlapping time periods rather than relying on a single calculation.

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