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What Is Compound Annual Growth Rate (CAGR)?

CAGR

CAGR, which stands for compound annual growth rate, is the rate at which an investment grows. Calculating the CAGR for an investment between two points (years) can show how well the investment performed in that time period. CAGR is useful for comparing the historical performance of investments. 

In this guide, we’ll go over:

What Is CAGR Used For?

Knowing the compound annual growth rate of an investment is useful for anyone working with investments. For instance, investment bankers can use CAGR to compare the historical returns of a company’s stocks. Or, private equity professionals can gauge how well an asset is performing compared to similar investments. 

Typically, CAGR is used retrospectively to see how well an investment has performed in the past. If an investment has a stable growth rate, CAGR could be used to predict future returns. However, it is important to note that CAGR shows a “smoothed” rate of return — it will not reflect high peaks or low valleys in the investments’ real history. Rather, CAGR gives a smooth line that balances out the peaks and valleys. 

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How to Calculate CAGR

Some important things to remember when calculating CAGR:

  1. CAGR assumes compounded growth, meaning any return on the investment is reinvested. For example, if you start with a $100 investment and after the first year see a return of $20, that $20 is also invested and gains returns. 
  2. CAGR offers a rate of return over a specific period of time. So, if you use CAGR to compare two different investments, you must use the same time period for both calculations. 
  3. CAGR gives a smoothed-out rate of return, so any inherent risks or volatility of an investment will not be shown.

CAGR Formula

The three key parts of the compound annual growth rate formula are: the chosen years, the value for both years, and the number of years in between. The formula for CAGR looks like this:

Components of CAGR Formula

  • Year X to Year Y: the period you want to look at
  • Value in Year Y: the value for the end of the time period
  • Value in Year X: the value for the beginning of the time period
  • N: the number of years between year X and year Y

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Example of CAGR Calculation

Let’s say you invest $500 in January 2018. By December, your investment is now worth $2,000. But, by December 2019, it has dropped to $400. Then, by December 2020, it has grown to $1,750. To see what the CAGR for 2018 to 2020 is, your components for the CAGR formula are:

  • Value in Year Y: $1,750
  • Value in Year X: $500
  • N: 3

N is three because the first year (2018) is included as one year. So, all of 2018, all of 2019, and all of 2020 total three full years of investing. 

CAGR = ($1,750/$500) ^ (1/3) – 1

So, the compound annual growth rate for this investment is 52%. A 52% growth is positive, but this highlights one of the key problems with using CAGR to evaluate an investment: It leaves out how volatile the investment was during that time period. 

While ultimately, the investment gave a return of $1,250 over three years, there was also a significant loss in the second year. CAGR is great to look at overall performance, but it is not a good metric of the volatility or risk involved with an investment. 

Learn how to calculate CAGR for top investment banking companies with these programs: 

How to Show CAGR Skills on Your Resume

Because CAGR is a relatively easy way to track investment history, it can be easily grouped with other skill sets. For example, you can imply you have knowledge of CAGR calculations by mentioning investment analysis skills in your resume’s skills section. 

Additionally, if you performed CAGR calculations as part of a prior work or internship experience, you could include “performed CAGR calculations on multiple investment portfolios to track performance” in your work or internship experience section. 

See more ways to showcase your hard skills

Calculating compound annual growth rates is an important skill for anyone with investments, but it is especially useful for finance professionals. Some other useful skills include:

You can learn these skills (and more!) using Forage’s Investment Banking Skills Passport.  

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