What is the Average Annual Growth Rate?
The average annual growth rate (AAGR) is the arithmetic mean of a series of growth rates.
Average Annual Growth Rate Formula
The average annual growth rate (AAGR) formula is:
AAGR = (Growth Rate in Period A + Growth Rate in Period B + Growth Rate in Period C + [Other Periods]) / Number of Periods
Let's look at an example. Assume that Company XYZ records revenues for the following years:
Using this information and the AAGR formula above, we can calculate the AAGR for the 2016-2019 period. Keep in mind the growth rate formula:
[Growth rate = (Ending Value - Beginning Value) / Beginning Value]
First, we calculate that the growth rate from 2016 to 2017 is ($1,200,000 - $1,000,000) / $1,000,000 = 20%.
The growth rate from 2017 to 2018 is ($1,300,000 - $1,200,000)/$1,200,000 = 8.3%.
The growth rate from 2018 to 2019 is ($1,400,000 - $1,300,000)/$1,300,000 = 7.7%.
Next, we add the growth rates together and divide by 3: (20% + 8.3% + 7.7%) / 3 = 12%.
In the example above, the AAGR across those years is 12%.
Why the Average Annual Growth Rate Matters
AAGR is somewhat useful for determining trends. It can be applied to almost any financial measure, including revenue, profit, expenses, cash flow, etc. to give investors an idea of which direction a company is headed for that particular measure.
But note that average annual growth rates can be very misleading. To illustrate, let's add a fourth period to our example and say that in 2020, revenues were $1,000,000. Our growth rate for period 4 is calculated as: $1,000,000 - $1,400,000) / $1,400,000 = -28.6%. That makes our AAGR (20% + 8.3% + 7.7% - 28.6%) = 7.4% / 4 = 1.85%. However, we can clearly see that our actual growth rate over four years is 0%. After all, we started with $1,000,000 and ended with $1,000,000.
Because of this phenomenon, AAGR is not regarded as the correct way to measure growth, and thus it is not a common formula for analysis. Most analysts use the compounded annual growth rate (CAGR) when evaluating changing financials.
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