Average Annual Growth Rate
What is the meaning of Average Annual Growth Rate?
Average annual growth rate refers to the average increase in an individual’s portfolio or investment value over a year’s period. The average annual growth rate can be evaluated for any kind of investment, but does not include any measure of the overall risk involved in the investment, as calculated by the volatility of its price.
As explained by Investopedia, if a portfolio grows 15% one year and 25% in the next year, the average annual growth rate would be 20%. To this end, the fluctuations occurring in the investment’s return rate between the beginning of the first year and the end of the year are not counted in the calculations thus leading to some errors in the measurement.
Formula for average annual growth rate
AAGR = (Growth Rate in Period A + Growth Rate in Period B + Growth Rate in Period C + ...Growth Rate in Period X) / Number of Periods
The concept of AAGR can be explained through the following illustration:
Let us presume that Company ABC records revenues for the following years:
With the help of this information and the abovementioned formula, the average annual growth rate can be estimated for 2000-2003 interim. As the first step, the growth rate for 2000-2001 is calculated as ($1,200,000 - $1,000,000)/$1,000,000 = 20%.
Similarly, the AAGR for 2001-2002 is calculated as ($1,300,000 - $1,200,000)/$1,200,000 = 8.3%
In the same way, the AAGR for 2002-2003 is calculated as ($1,400,000 - $1,300,000)/$1.300,000 = 7.7%
Going ahead, these growth rates are added together and then divided by 3: (20% + 8.3% + 7.7%) = 12%
The Average Annual Growth Rate (AAGR) is, therefore, the arithmetic mean of a series of growth rates.
Why AAGR matters
The average annual growth rate is quite helpful in determining the trends. It is applicable to almost any kind of financial measure, counting profit, revenue, cash flow, expenses, etc. to provide the investors with an idea about the direction wherein the company is headed for a specific measure.