Growth rates and CAGR

The compound annual growth rate is the constant rate that would take a starting value to an ending value over a given number of years. Divide the end by the start, take the nth root where n is the number of years, and subtract one.

Revenue rising from $100m to $161m over five years is a CAGR of 10%, because $100m compounded at 10% for five years is $161m. The arithmetic is exact and it uses precisely two of the six numbers involved.

That is the whole of both its usefulness and its weakness. It converts a decade into one comparable figure, and it does so by discarding the path.

The two companies below post an identical 10% five-year CAGR. One grew steadily; the other lost a third of its revenue, spent three years recovering, and finished in the same place.

A screen sorted on CAGR treats them as equivalent. They are not: the first describes a business with durable demand and the second a business with a cycle, and the difference is exactly what the ratio removed.

This is why growth is worth reading as a series rather than as a number, and why the company pages show ten years of each line rather than a summary rate.

Because only the endpoints count, the choice of start year determines the rate. Measuring from a cyclical trough produces a flattering figure and measuring from a peak produces a poor one, for the same company over almost the same period.

A five-year rate that begins in a recession year and a ten-year rate covering the same recovery will disagree, and neither is wrong. This is why growth figures in company presentations deserve a look at which year they start from.

The screener carries both five and ten-year CAGRs for revenue and for free cash flow per share. Where the two disagree materially, the shorter one is usually measuring a recovery rather than a trend.

Revenue growth is the cleanest, because revenue is the hardest line to adjust and the closest to what customers actually did.

Earnings growth can outpace revenue growth through margin expansion, which is real, or through buybacks reducing the share count, which is not the same thing. Comparing revenue growth against EPS growth separates them.

Free cash flow growth is the one that eventually has to be true, since dividends and buybacks are paid from cash. It is also the noisiest year to year, because capital spending is lumpy, which is why a multi-year rate is the right form for it.

Dividend growth is a statement of policy rather than of performance. It reflects what a board chose to distribute, and it can continue for a while after the earnings supporting it have stopped growing.

An acquisition adds revenue immediately, so a company that buys another grows at whatever rate the purchase implies. That is growth, and it is not the same as selling more to more customers.

The distinction is organic growth against total growth, and companies that grow by acquisition usually disclose both. Rising revenue alongside rising share count and rising debt is the signature of growth that was purchased, and the return on it shows up later in return on invested capital rather than in the growth rate.

Comparing CAGRs measured over different periods or from different start years.

Reading a high rate off a small base, where a rise from $2m to $20m is a 58% CAGR and says little about what happens at $200m.

Averaging annual growth rates instead of compounding them. The arithmetic mean of +50% and -50% is zero; the actual result is a 25% loss.

Treating EPS growth as business growth without checking the share count.

Extrapolating a historical rate. A CAGR is a description of what happened, and nothing about it is a forecast.