ValueThe CAGR formula
CAGR answers a simple question: at what steady yearly rate would a value have had to grow to get from A to B? The formula is:
CAGR = (ending value / beginning value)^(1 / years) - 1
It compresses a bumpy ride into a single smooth rate. A stock that went $10,000 to $16,289 over 5 years grew at about 10.25% per year compounded, regardless of how wildly it swung in between. That smoothing is the whole point: it makes different investments, companies, and time periods directly comparable.
Why CAGR beats "average return"
Averages lie about compounding. Consider an investment that gains 50% in year one and loses 50% in year two. The simple average return is 0%, which sounds like breaking even. In reality, $100 became $150 and then $75: you lost 25%. The CAGR is (75/100)^(1/2) - 1 = -13.4% per year, the true story.
This matters everywhere in investing: fund marketing loves arithmetic averages, and "average analyst growth forecasts" have the same flaw. Whenever someone quotes you a growth number, ask whether it compounds. If it does not, run it through the calculator above.
Using CAGR to sanity-check a DCF
The most valuable use of this page for a valuation workflow is as a reality check on the DCF calculator's growth input. DCF growth assumptions are where optimism sneaks in, so anchor them:
- Compute the historical CAGR of the company's revenue and free cash flow over the last 5 and 10 years using the tool above.
- Compare it to your forecast. If history says 6% and your DCF assumes 15%, you need a concrete reason: a new product line, a completed acquisition, a structural market shift. "Management is optimistic" is not a reason.
- Check what peers achieved. Sustained 20%+ growth is rare in any industry. If no comparable company has ever compounded that fast for that long, your forecast is a bet on this company being the exception.
- Run the reverse check too. The reverse DCF calculator shows what growth the market is pricing in; compare that number to the historical CAGR as well.
The rule of 72
A handy mental shortcut: divide 72 by the annual growth rate to estimate doubling time. At 8% per year, money doubles in about 9 years; at 12%, about 6 years. The calculator shows this automatically as the "rule of 72 check." It is approximate (it works best for rates between 6% and 10%), but it is a fast way to feel whether a growth assumption is aggressive. Someone forecasting 25% annual growth for a decade is really forecasting the business to grow roughly 9x, because 72/25 means it doubles about every 3 years. Stated that way, forecasts often reveal themselves.
Limitations
- CAGR hides volatility. Two investments with the same CAGR can have wildly different risk. It tells you the destination, nothing about the ride.
- It is sensitive to endpoints. Starting in a crash year or ending in a boom year flatters the rate. Use multiple periods, or normalize the endpoints across a business cycle.
- Past growth does not predict future growth. A historical CAGR is an anchor for judgment, not a forecast. Businesses slow as they grow; a small company compounding at 30% will almost certainly not do so at ten times the size.
- The projector assumes a constant return. Real returns vary year to year, and the sequence matters when you are contributing or withdrawing. Treat the projection as a central illustration, then test lower returns too.
Frequently asked questions
Can CAGR be negative?
Yes. If the ending value is below the beginning value, the CAGR is negative, showing the steady annual rate of decline. For example, $10,000 falling to $8,000 over 5 years is about -4.4% per year.
Why does my "average return" differ from the CAGR?
Because a simple average of yearly returns ignores compounding. CAGR is the geometric mean, which accounts for compounding and is the correct measure of growth over multiple periods. The gap between the two grows with volatility.
How many years should I use for a historical CAGR?
Longer is usually more informative: 5-10 years smooths out cycles. But check that the business is comparable across the whole period; a company that transformed itself three years ago is better measured from the transformation.
Are contributions assumed at the start or end of each year?
End of each year. Each contribution starts compounding the following year. This matches the standard future-value-of-an-annuity convention used in finance textbooks.
What is a good CAGR for an investment?
The long-run return of the broad stock market is roughly 7 to 10 percent per year before inflation. Anything consistently above that usually involves more risk or leverage. Compare your CAGR against a relevant benchmark, not against other investors' best years.