Understanding Average Annual Growth Rate (AAGR): Definition & Uses

The average annual growth rate (AAGR) is the average annual appreciation in the value of an investment asset, portfolio, or cash flow. It is determined by taking the numerical mean of specified or calculated year-on-year growth rates.

The average annual growth rate is used for many fields – for example, in economics, in which AAGR provides a clear understanding of shifts in economic performance (e.g. actual GDPGDP FormulaGross Domestic Product (GDP) is the monetary value, in local currency, of all final economic goods and services produced in a country during a growth rate).

The AAGR is normally presented as a percentage.

Summary

• The average annual growth rate (AAGR) is the average increase or decrease in the value of an investment asset, portfolio, or cash flow over a specified period of time.
• The AAGR is determined by taking the numerical mean of specified year-on-year growth rates.
• The AAGR can be estimated for any investment; however, it will not provide any indication of the potential risk of the investment, as determined by its price fluctuations.

Uses of the Average Annual Growth Rate (AAGR)

The AAGR is useful in assessing long-term trends. It is relevant to nearly any form of financial metric analysis, such as the growth rate of earningsIncome vs Revenue vs EarningsIncome, revenue, and earnings are probably the three most widely used concepts in accounting and finance. All the terms denote measures of a, sales, cash flow, expenditures, etc., to give investors an indication of the direction in which the firm is going. The AAGR depicts, on average, what the annual returns have been.

AAGR Formula

Annual Average Growth Rate = [(Growth Rate)_y + (Growth Rate)_y+1  + … (Growth Rate)_y+n] / N

Where:

• Growth Rate (y) – Growth rate in year 1
• Growth Rate (y + 1) – Growth rate in the next year
• Growth Rate (y + n) – Growth rate in the year “n”
• N – Total number of periods

How the AAGR is Calculated

The AAGR is a benchmark for calculating the average return on investments over a number of years. Essentially, it is the basic average growth rates of return for a sequence of periods (years).

To compute the average, the growth rate for each individual time period in the series must be computed. It can be done by using the basic formula below:

Growth Rate Percentage  =  ((EV / BV) – 1) x 100%

Where:

• EV is the ending value
• BV is the beginning value

Once the growth rate percentages for each time period have been calculated, they are added together and divided by the total number of the time periods, giving the AAGR.

One point to always take into consideration is that the periods used should be equal in length when calculating the growth rates. These time periods can be year-on-year, month-on-month, quarterly, etc., depending on the specific needs of the person or firm computing the growth rates.

Step-by-Step Example

Given the following annual revenues for ABC Company:

Year 1: $250,000

Year 2: $356,000

Year 3: $390,000

Year 4: $395,000

Year 5: $400,000

Year 6: $358,000

Year 7: $320,000

Using the growth rate formula above, the growth rates from Years 1 to 7 can be computed as:

Y1: 0, because there is no preceding time period

Y2: [(356,000/250,000)-1] x 100% = 42.4%

Y3: [(390,000/356,000)-1] x 100% = 9.7%

Y4: [(395,000/390,000)-1] x 100% = 101.3%

Y5: [(400,000/395,000)-1] x 100% = 101.3%

Y6: [(358,000/400,000)-1] x 100% = -10.5%

Y7: [(320,000/358,000)-1] x 100% = -10.6%

And the AAGR is calculated as:

Sum of Growth Rates =  [42.4 % + 9.7 % + 101.3 % + 101.3 % + (-10.5 %) + (-10.6 %)]

=  233.6%

AAGR  = 233.6 % / 7

= 33.4%

The average annual growth rate for ABC Company is 33.4%.

Average Annual Growth Rate (AAGR) Restrictions in Financial Analysis

Consider a portfolio that grows by 25% in the first year and 12% in the following year. The average annual growth rate (AAGR) would be calculated as 18.5%. The fluctuations in the return rate of the portfolio between the start of the first year and the end of the year are not taking into consideration the average annual growth rate calculation.

It can lead to certain mistakes in the estimation. Since AAGR is an average of the annual returns, the metric does not provide an estimate of the total risk associated with an investment, as estimated by the instability of its price. Basically, AAGR can be estimated for any investment; however, it will not provide any indication of the potential risk of the investment.

Furthermore, AAGR does not accommodate the effects of compounding, as it is a linear metric. An analysis can show that an investment has grown by an average of n percent per year, whilst missing the fluctuations that may have occurred during the time period series.

Ideal for showing trends, AAGR can also be deceptive to investors since it does not adequately reflect changing financial trends. Also, the growth of an investment can be overestimated.

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program, designed to help anyone become a world-class financial analyst. To keep learning and advancing your career, the additional CFI resources below will be useful:

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