what the cagr can tell you
the compound annual growth rate isn t a true return rate but rather a representational figure it is essentially a number that describes the rate at which an investment would have grown if it had grown at the same rate every year and the profits were reinvested at the end of each year for stock market investors this can be particularly useful in comparing the performance of different stocks the cagr does not take into account the discount rate which is critical in assessing the present value of future returns in reality this sort of performance is unlikely however the cagr can be used to smooth returns so that they may be more easily understood compared to alternative methods example of how to use cagrimagine you invested 10 000 in a portfolio with the returns outlined below we can see that on an annual basis the year to year growth rates of the investment portfolio were quite different as shown in the parentheses on the other hand the compound annual growth rate smooths the investment s performance and ignores the fact that 2018 and 2020 were vastly different from 2019 the cagr over that period was 23 86 and can be calculated as follows c a g r 19 000 10 000 1 3 1 100 23 86 cagr left frac 19 000 10 000 right frac 1 3 1 times100 23 86 cagr 10 000 19 000 31 1 100 23 86 the cagr of 23 86 over the three year investment period can help an investor compare alternatives for their capital or make forecasts of future values for example imagine an investor is comparing the performance of two uncorrelated investments in any given year during the period one investment may be rising while the other falls this could be the case when comparing high yield bonds to stocks or a real estate investment to emerging markets using cagr would smooth the annual return over the period so the two alternatives would be easier to compare as another example let s say an investor bought 55 shares of amazon com amzn stock in december 2017 at 1 180 per share for a total investment of 64 900 after three years in december 2020 the stock has risen to 3 200 per share and the investor s investment is now worth 176 000 1 what is the cagr using the cagr formula we know that we need the so to calculate the cagr for this simple example we would enter that data into the formula as follows 176 000 64 900 1 3 1 39 5 additional cagr usesthe cagr can be used to calculate the average growth of a single investment as we saw in our example above due to market volatility the year to year growth of an investment will likely appear erratic and uneven for example an investment may increase in value by 8 in one year decrease in value by 2 the following year and increase in value by 5 in the next cagr helps smooth returns when growth rates are expected to be volatile and inconsistent the cagr produces a geometric mean which can be used to compare different investment types with one another for example suppose that in 2015 an investor placed 10 000 into an account for five years with a fixed annual interest rate of 1 and another 10 000 into a stock mutual fund the rate of return in the stock fund will be uneven over the next few years so a comparison between the two investments would be difficult assume that at the end of the five year period the savings account s balance is 10 510 10 and although the other investment has grown unevenly the ending balance in the stock fund was 15 348 52 using the cagr to compare the two investments can help an investor understand the difference in returns savings account cagr 10 510 10 10 000 1 5 1 100 1 00 text savings account cagr left frac 10 510 10 10 000 right frac 1 5 1 times 100 1 00 savings account cagr 10 000 10 510 10 51 1 100 1 00 and stock fund cagr 15 348 52 10 000 1 5 1 100 8 95 text stock fund cagr left frac 15 348 52 10 000 right frac 1 5 1 times 100 8 95 stock fund cagr 10 000 15 348 52 51 1 100 8 95 on the surface the stock fund may look like a better investment with nearly nine times the return of the savings account on the other hand one of the drawbacks of the cagr is that by smoothing the returns the cagr cannot tell an investor how volatile or risky the stock fund was however the cagr can be used in the mar ratio which adjusts for risk using the cagr alongside metrics like net present value npv provides a more comprehensive view of an investment s potential the cagr can also be used to track the performance of various business measures of one or multiple companies alongside one another for example over a five year period big sale stores market share cagr was 1 82 but its customer satisfaction cagr over the same period was 0 58 in this way comparing the cagrs of measures within a company reveals strengths and weaknesses comparing the cagrs of business activities across similar companies will help evaluate competitive weaknesses and strengths for example big sale s customer satisfaction cagr might not seem so low compared with superfast cable s customer satisfaction cagr of 6 31 during the same period 