CAGR stands for compound annual growth rate and is the mean annual growth rate of an investment over a specific period. Using the results from the compound annual growth rate calculation is one of the most accurate ways to calculate and determine returns for assets. It is mainly used to measure and compare previous investment performances or to help project the returns of a future project. An example of a CAGR calculation would be if an investment of £1,000 gave a 25% return in the first year this raised the total to £1,250. In the second year if all capital was reinvested and gave a -25% return this would take the total down to £937.50, which is now less than the initial investment. This would give a CAGR of -3% over this two year period. Indicates to investors what they will have at the end of an investment period.
Using CAGR is very useful for comparing the results of different investments over a certain timeframe however it does have its limitations. One disadvantage is that a CAGR assumes growth to be consistent throughout the timeframe, however in many instances this is not the case. Using the example above the CAGR doesn’t show that in fact the returns grew by 25% in the first year.
For more information on CAGR check out our blog - What is a good CAGR?
What is ROI?
ROI stands for return on investment and is used to evaluate the efficiency or profitability of an investment. This calculation tries to directly measure the amount of return on a particular investment. There are three ways to measure a company’s return on investment using time, rate of return and extra value. When using time to measure ROI, a simple measure called Payback is used to tell you when you get your money back. It compares the costs against the benefits and allows you to see the point at which you will gain all your invested money back. Rate of return is also used to help measure ROI and is known as Internal Rate of Return. This gives you an annual returns percentage that is found when comparing the money spent upfront against the future benefits. A last way to help measure ROI is through measuring the Net Present Value. This shows a result as a money profit by looking at all the benefits minus the upfront costs and adding a cost of money to bring it to a today value (the present in NPV).
We have written lots more information about ROI- check it out - What is "ROI"?
What is the difference?
There are several differences between a compound annual growth rate and return on investment. Firstly, CAGR is used to find the growth rate of an investment of a company per year whereas ROI can be used for different time periods. This can make ROI more accurate than CAGR when calculating profit for an investment. Another difference is that the CAGR is more simple to work out, the rate can be calculated by hand and requires only 3 simple inputs: the beginning value, ending value and time period. ROI is more complicated to calculate but can give more accurate results and provide better measures of profitability for an investment.
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FAQs
Another difference is that the CAGR is more simple to work out, the rate can be calculated by hand and requires only 3 simple inputs: the beginning value, ending value and time period. ROI is more complicated to calculate but can give more accurate results and provide better measures of profitability for an investment.
What is the difference between CAGR and ROI? ›
For estimating investment profit, ROI may be more accurate than CAGR because of this. There is one more distinction: the CAGR is more accessible to calculate. It just needs three essential inputs to be calculated by hand: the start value, the end value, and the time period.
What is the difference between total return and CAGR? ›
The main difference is that the CAGR is often presented using only the beginning and ending values, whereas the annualized total return is typically calculated using the returns from several years. This, however, is more a matter of convention. In substance, the two measures are the same.
What is the difference between average return and CAGR? ›
The CAGR is superior to an average returns figure because it takes into account how an investment is compounded over time.
What is the difference between CAGR and revenue growth rate? ›
The main difference between the CAGR and a growth rate is that the CAGR assumes the growth rate was repeated, or “compounded,” each year, whereas a traditional growth rate does not. Many investors prefer the CAGR because it smooths out the volatile nature of year-by-year growth rates.
What is the difference between cumulative return and annualized return CAGR? ›
Additionally, an annualized return takes into account the time value of money, meaning that it accounts for the fact that money today is worth more than money in the future. Cumulative return does not take this into account.
What is the difference between CAGR and compound interest? ›
CAGR considers the compounding effect, where the growth each year contributes to the base value for subsequent years. It gives you a single rate of growth that reflects the investment's overall performance, making it easier to compare different investments.
What is the CAGR in simple terms? ›
The compound annual growth rate (CAGR) is the annualized average rate of revenue growth between two given years, assuming growth takes place at an exponentially compounded rate.
When should you use CAGR? ›
CAGR is the best formula for evaluating how different investments have performed over time. Investment results can vary depending on the time periods that are used. Investors can use a risk-adjusted CAGR to compare the performance and risk characteristics between investment alternatives.
What percentage of CAGR is considered good? ›
Determining a Good CAGR: A specific percentage for a good CAGR in stock market equity investments varies but should ideally surpass savings account interest rates. Large-cap Investments: Historically, large, stable companies have provided 8% to 12% returns for long-term investors.
CAGR Reflects the Actual
Calculating your ROR this way typically results in a lower number because it isn't taking into account the ROR in particularly good and bad years, it only accounts for what has actually been earned.
What is the CAGR rule? ›
Next, determine the ending value, which is the value at the end of the specified period. Now, calculate the total number of years over which the growth occurred. Use the CAGR Formula: CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1.
What is the difference between average annual return and compounded annual return? ›
Compound return is viewed as a much more accurate measure of performance of an investment's return over time than the average return. This is because the average annual return does not take compounding into effect, which results in a gross misstatement of an investor's actual returns.
How are ROI and CAGR different? ›
There are several differences between a compound annual growth rate and return on investment. Firstly, CAGR is used to find the growth rate of an investment of a company per year whereas ROI can be used for different time periods. This can make ROI more accurate than CAGR when calculating profit for an investment.
Is CAGR and rate of return same? ›
Is CAGR the same as annual return? Yes, CAGR is essentially the same as the annualized return. Both terms refer to the measure of an investment's performance over a specific period, showing the growth from the beginning to the ending value over that time frame.
What is the difference between rate of return and growth rate? ›
The Bottom Line
RoR is expressed as a percentage of the initial value. The internal rate of return (IRR) also measures the performance of investments or projects, but while ROR shows the total growth since the start of the project, IRR shows the annual growth rate.
Which is better, CAGR or absolute return? ›
If your holding period is less than a year, absolute return is a better metric to use when calculating the return from your investment. However, CAGR makes up for a better calculation metric for mutual fund investments with a holding period longer than one year.
Is ROI the same as gross profit margin? ›
Where ROI focuses on what you invested in your inventory, Profit Margin is focused more on the total price you sold your inventory at and can never exceed 100%. As an example, if you purchased a unit for $1, had total fees of $2, and sold the unit for $10, your profit margin would be 70%.
What is considered a good CAGR rate? ›
For large-cap companies, a CAGR in sales of 5-12% is good. Similarly, for small companies, a CAGR between 15% to 30% is good. On the other hand, start-up companies have a CAGR ranging between 100% to 500%. Also, such high growth rates in the early stages are not completely abnormal.
What is the difference between ROI and rate of return? ›
Return on investment (ROI) and internal rate of return (IRR) are both ways to measure the performance of investments or projects. ROI shows the total growth since the start of the projact, while IRR shows the annual growth rate. Over the course of a year, the two numbers are roughly the same.
