What Is Average Annual Growth Rate (AAGR)?

What Is Average Annual Growth Rate (AAGR)?

Let me explain what the average annual growth rate, or AAGR, really is. It's the mean increase in the value of an individual investment, portfolio, asset, or cash flow, calculated on an annualized basis. You get it by taking the arithmetic mean of a series of growth rates, and it's always expressed as a percentage. Keep in mind, though, that it doesn't factor in compounding at all.

You'll see AAGR used widely in various contexts. For instance, it's common for analyzing a country's gross domestic product (GDP), a company's revenues or profits, and the performance of investments like mutual funds or stocks.

Key Takeaways on AAGR

To break it down simply, AAGR is the average annualized return of an investment, portfolio, asset, or cash flow over a given time frame. You can use it to analyze a range of financial metrics, from a company's financial statements to economic indicators like GDP and even investment returns. The calculation is straightforward: just take the simple arithmetic mean of a series of returns.

It offers a simple way to measure and compare performance across several years, but remember, it ignores the effects of compounding. Also, watch out for its drawbacks—it can be sensitive to outliers and fluctuations, and it might give you the false impression of a constant growth rate.

Formula for Average Annual Growth Rate (AAGR)

Here's how you calculate AAGR directly: AAGR = (GR_A + GR_B + … + GR_n) / N, where GR_A is the growth rate in period A, GR_B in period B, and so on up to GR_n in period n, and N is the number of periods. That's the formula in its basic form.

Understanding the Average Annual Growth Rate (AAGR)

AAGR is a tool that helps you determine long-term trends. I use it to assess the performance of investments, businesses, and even economies over multiple years. It gives you the mean annualized rate of growth for whatever you're looking at. To compute it, add up the individual growth rates and divide by the total number of time periods. It's easy to calculate, it smooths out fluctuations, and it makes comparisons across different datasets and timeframes straightforward.

One tip I'll give you: make sure all the periods you're using are of equal length, like years, months, or weeks. AAGR applies to various financial metrics, such as a company's revenue, profit, and market share, or economic indicators like GDP and employment rates, plus investment returns. But note that it won't include any measure of the investment's overall risk, like price volatility, and it doesn't account for periodic compounding.

AAGR Examples

The AAGR measures the average rate of return or growth over equally spaced time periods. Let me walk you through a couple of examples to make this clear.

First, consider a financial investment. Suppose an investment starts at $100,000 and grows to $120,000 by the end of year 1, $135,000 by year 2, $160,000 by year 3, and $200,000 by year 4. The growth rates are 20% for year 1, 12.5% for year 2, 18.5% for year 3, and 25% for year 4. Adding those up and dividing by 4 gives you an AAGR of 19%. In finance and accounting, we usually use beginning and ending prices, but some analysts might opt for average prices depending on the analysis.

As another example, look at the U.S. real GDP growth rates from 2019 to 2023: 2.5%, -2.2%, 5.8%, 1.9%, and 2.5%. The AAGR here is 2.1%, calculated by summing those rates and dividing by 5.

AAGR vs. Compound Annual Growth Rate (CAGR)

AAGR is a linear measure that skips the effects of compounding. In the financial investment example I gave, the growth averaged 19% per year over four years, which is useful for trends but can mislead you about changing financials and sometimes overestimate growth.

For instance, if you add a fifth year where the value drops to $100,000, that's a -50% growth, making the AAGR 5.2%. But the actual return from start to end is 0%. In cases like this, you might find the compound annual growth rate (CAGR) more useful, as it smooths out returns and accounts for volatility.

The CAGR formula is CAGR = (Ending Balance / Beginning Balance)^(1 / # Years) - 1. Using the first four years of the example, it's 18.92%. But including the fifth year drops it to 0%, highlighting the contrast with AAGR.

Limitations of the AAGR

AAGR is just a simple average of periodic annual returns, and it has flaws you need to be aware of. It's sensitive to outliers and fluctuations, and it can create the impression of constant growth when that's not the reality. Another issue is that it doesn't account for risk—one investment might have a higher AAGR but be far more volatile.

What Does the Average Annual Growth Rate (AAGR) Tell You?

AAGR identifies long-term trends in financial measures like cash flows or investment returns. It shows you the average annual return, but without considering compounding.

What Are the Limitations of Average Annual Growth Rate?

AAGR can overestimate growth if there are mixed positive and negative returns. It doesn't include risk measures like price volatility or factor in the timing of returns.

How Does Average Annual Growth Rate Differ From Compounded Annual Growth Rate (CAGR)?

AAGR is the average increase, a linear measure without compounding. CAGR, on the other hand, accounts for compounding and smooths out return volatility.

How Do You Calculate the Average Annual Growth Rate (AAGR)?

You calculate AAGR by finding the growth rate for each period, adding them up, and dividing by the number of periods.

The Bottom Line

In summary, the average annual growth rate (AAGR) gives you the arithmetic mean of a series of growth rates and serves as a common indicator of performance and a comparison tool in finance. With its simple calculation, you can see the average annualized return over multiple years. However, its simplicity brings drawbacks, so don't rely on it alone for decisions.