Average Annual Growth Rate Details

The average annual growth rate, also referred to as AAGR, is the average appreciation in the value of a business, asset, investment, or cash flow over one year. One year's period refers to an accounting period of one year and does not necessarily mean one calendar year.

The accounting year of some businesses is the same as the calendar year. Other companies opt to use fiscal years, which can begin from any part of the calendar year and ends 12 months later. For an investment, the AAGR does not indicate the volatility or risk of the investment.

The AAGR is used to show trends over extended periods. What makes the AAGR interesting is that it can be applied to all metrics used in measuring business performance. Some metrics that the AAGR can be applied to include revenue, profit, cash flow, and expenses.

How Investors Use Annual Annual Growth Rate

Investors use the AAGR to determine the performance of a business quickly. This is typically useful if an investor wants to know a company's standings before committing to an investment. Keep in mind the AAGR does not include any periods of compounding.

Although the AAGR is useful in giving a quick picture of a company's performance over a long period, it does not indicate the risk involved in the business or investment, mostly due to the volatility of the price.

Imagine you have an investment portfolio that has returned 10% in the first year and 15% in the second year. If you calculate the AAGR for the two years, the average annual growth rate will be 12.5%. You can see that the average annual growth rate of 12.5% does not indicate the fluctuations in the rate of returns between the two years. Investors like to critically analyze risk before committing to an investment.

Average Annual Growth Rate Example

The example below will illustrate the average annual growth rate. It will show how to calculate the average annual growth rate.

Lukas Dew is a company that produces skin care products. It has been in business for more than ten years and has successfully carved out a market share. With the vision to be the preferred skincare product in every home, they have aggressively pursued expansion and growth.

To achieve its growth target, Lukas Dew is currently seeking investors to help fund the desired growth. However, the investors that Lukas Dew has met with are requesting its average annual growth rate. The yearly valuation of Lukas Dew for the past six years are shown below.

  • Beginning of the first year: $2 million
  • End of the first year: $2.5 million
  • End of the second year: $2. 9 million
  • End of the third year: $3.4 million
  • End of the fourth year: $4 million
  • End of the fifth year: $4.6 million
  • End of the sixth year: $5.1 million

The first step is to calculate the yearly growth rate. The yearly growth rate is determined by:

( ( Ending value – beginning value ) / beginning value ) * 100%

Note that the ending and beginning values refer to the beginning and ending values for each year.

Using the formula above, calculate the yearly growth rate:

  • For year 1: ( ( $2.5 million - $2 million ) / $2 million ) * 100% = 25%
  • For year 2: ( ( $2.9 million - $2.5 million ) / $2.5 million ) * 100% = 16%
  • For year 3: ( ( $3.4 million - $2.9 million ) / $2.9 million ) * 100% = 17%
  • For year 4: ( ( $4 million - $3.4 million ) / $3.4 million ) * 100% = 17.6%
  • For year 5: ( ( $4.6 million - $4 million ) / $4 million ) * 100% = 15%
  • For year 6: ( ( $5.1 million - $4.6 million ) / $4.6 million ) * 100% = 10.9%

Now proceed with determining the average annual growth rate. The formula for AAGR is:

AAGR = ( G1 + G2 + G3 + G4… GN ) / N

Where:

  • AAGR is the average annual growth rate.
  • G1 is the yearly growth rate for year one.
  • G2 is the yearly growth rate for year two.
  • G3 is the yearly growth rate for year three.
  • G4 is the yearly growth rate for year four.
  • GN is the yearly growth rate for the nth year.
  • N is the number of years.

From the question above, the number of years is 6, so N is 6. Please note, when calculating the AAGR, the years must be consecutive, i.e., the years should follow each other. As mentioned earlier, the years can be calendar years or fiscal years; it doesn’t matter as long as the years are consecutive.

AAGR = ( 25% + 16% + 17% + 17.6% + 15% + 10.9% ) / 6

AAGR = 101.5% / 6

AAGR = 16.9%

So the average annual growth rate of Lukas Dew is 16.9%, which is okay for a company in the skincare industry. Investors should be satisfied with the average annual growth rate.