Compound annual growth rate, or CAGR, is the constant yearly rate that would take a starting value to an ending value over a given number of years.

Compound annual growth rate, or CAGR, is the constant yearly rate that would take a starting value to an ending value over a given number of years. It converts a multi-year change into a single annualized growth rate, which makes it a useful summary measure when comparing outcomes across different time spans or paths of returns.

The standard formula is:

CAGR = (Ending Value / Starting Value)^(1 / Number of Years) - 1

This formula asks a simple question. If growth had occurred at one steady annual rate instead of changing from year to year, what rate would exactly reproduce the observed ending value from the observed starting value over the same period.

A step by step example makes the mechanism clear. Suppose a portfolio starts at 100 and ends at 150 after 5 years.

First, divide the ending value by the starting value:

150 / 100 = 1.5

Second, take the fifth root because the period is 5 years:

1.5^(1/5) ≈ 1.08447

Third, subtract 1 to convert the growth factor into a rate:

1.08447 - 1 = 0.08447

So the CAGR is about 0.0845, or 8.45% per year.

This does not mean the value actually grew by 8.45% every year. CAGR is a smoothed annual rate. It abstracts from the sequence of returns and ignores the year to year volatility in the path between the starting and ending values. For example, one investment path might rise and fall sharply before finishing at 150, while another might grow steadily to the same endpoint. If both begin at 100 and end at 150 after 5 years, both have the same CAGR even though their realized paths were very different.

That smoothing is the main strength and the main limitation of CAGR. Its strength is clarity. It summarizes total growth over time in a single annualized number. Its limitation is that it hides variability, drawdowns, and the order in which returns occurred. For performance measurement, CAGR is therefore best understood as a geometric average growth rate that matches the beginning and ending values over the stated horizon, not as a description of the actual return earned in each individual year.

Covered in depth in the Strategy research fundamentals pillar hub.