CAGR is one of the most commonly used metrics in financial analysis and one that interviewers expect you to understand intuitively. It appears in management presentations, equity research reports, PE investment memos, and pitch books. This guide covers the formula, when to use it, and the nuances that separate a good answer from a great one.
What Is CAGR?
Compound Annual Growth Rate measures the smoothed annual rate of return that an investment or metric would have achieved if it had grown at a steady rate over a specified period.
The formula:
\(\text{CAGR} = (\text{Ending Value} / \text{Beginning Value})^(1/n) − 1\)
Where n is the number of years.
If a company's revenue grew from £100m to £161m over 5 years:
CAGR = (161/100)^(1/5) − 1 = (1.61)^0.2 − 1 = 10.0%
This means revenue grew at an equivalent rate of 10% per year, compounded. The actual year-by-year growth may have been lumpy – maybe 15% one year, 5% the next – but the CAGR smooths it into a single, annualised figure.
'What's the revenue CAGR?' is a question you'll face repeatedly in deal discussions and case studies. You should be able to calculate CAGR quickly – either mentally for simple cases or by setting up the formula in Excel. For mental maths: the Rule of 72 helps. If something doubles, the CAGR ≈ 72 / number of years. Doubled in 5 years ≈ 14.4% CAGR. Doubled in 7 years ≈ 10.3% CAGR.
CAGR vs Average Growth Rate
This distinction is important and frequently tested:
Average Growth Rate: Add up each year's growth rate and divide by the number of years.
CAGR: Based only on the beginning and ending values, ignoring the path in between.
Consider: a company's revenue is £100m in Year 0, £200m in Year 1 (100% growth), and £100m in Year 2 (−50% growth).
Average Growth Rate = (100% + −50%) / 2 = 25%
CAGR = (100/100)^(1/2) − 1 = 0%
The average growth rate of 25% is misleading – the company ended exactly where it started. The CAGR of 0% is accurate. This is why CAGR is preferred for measuring growth over multiple periods: it captures the compounding effect and tells you what actually happened to the value.
When to Use CAGR
Revenue and earnings growth analysis: 'Revenue grew at a 12% CAGR from 2020 to 2025' is cleaner and more comparable than listing each year's growth rate.
Investment returns: CAGR is the standard way to report returns over multi-year periods. A PE fund that turned £100m into £300m over 6 years generated a 20% CAGR.
Market sizing: Industry reports typically express market growth as a CAGR: 'The UK fintech market is expected to grow at a 15% CAGR from 2025 to 2030.'
Benchmarking: Compare companies' growth rates on a like-for-like basis by using CAGR over the same time period.
Limitations
Ignores volatility: CAGR smooths over year-to-year variation. A company that grew 50%, then shrank 30%, then grew 40% has a very different risk profile from one that grew steadily at 15% per year – but their CAGRs might be similar.
Sensitive to start and end points: Choosing a peak year as the start and a trough year as the end (or vice versa) can dramatically skew the CAGR. Always be thoughtful about the time period selected.
Doesn't reflect size or absolute magnitude: A 20% CAGR on a £10m base is very different from a 20% CAGR on a £10bn base. The law of large numbers makes high CAGRs increasingly difficult to sustain as a business scales.
'A company grew revenue at a 25% CAGR over 5 years. Is that impressive?' It depends on the context. 25% CAGR for a $50bn company is extraordinary. For a £5m startup, it might be below expectations. Always contextualise CAGR with absolute numbers, industry benchmarks, and the competitive landscape.
Quick CAGR Reference
For mental maths in interviews, these approximations are useful: 7% CAGR ≈ doubles in 10 years; 10% CAGR ≈ doubles in ~7 years; 15% CAGR ≈ doubles in ~5 years; 20% CAGR ≈ doubles in ~3.6 years; 25% CAGR ≈ doubles in ~3 years.
Our AI tutor covers CAGR, growth analysis, and quantitative concepts.
Try it free.
