Average Annual Growth Rate (AAGR): Definition and Calculation

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Average Annual Growth Rate (AAGR): Definition and Calculation

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What Is Average Annual Growth Rate (AAGR)?

The average annual growth rate (AAGR) reports the mean increase in the value of an individual investment, portfolio, asset, or cash flow on an annualized basis. It doesn’t take compounding into account.

Key Takeaways

  • Average annual growth rate (AAGR) is the average annualized return of an investment, portfolio, asset, or cash flow over time.
  • AAGR is calculated by taking the simple arithmetic mean of a series of returns.
  • AAGR is a linear measure that does not account for the effects of compounding—to account for compounding, compound annual growth rate (CAGR) would be used instead.

Formula for Average Annual Growth Rate (AAGR)


A A G R = G R A + G R B + + G R n N where: G R A = Growth rate in period A G R B = Growth rate in period B G R n = Growth rate in period  n N = Number of payments \begin{aligned} &AAGR = \frac{GR_A + GR_B + \dotso + GR_n}{N} \\ &\textbf{where:}\\ &GR_A=\text{Growth rate in period A}\\ &GR_B=\text{Growth rate in period B}\\ &GR_n=\text{Growth rate in period }n\\ &N=\text{Number of payments}\\ \end{aligned}
AAGR=NGRA+GRB++GRnwhere:GRA=Growth rate in period AGRB=Growth rate in period BGRn=Growth rate in period nN=Number of payments

Understanding the Average Annual Growth Rate (AAGR)

The average annual growth rate helps determine long-term trends. It applies to almost any kind of financial measure including growth rates of profits, revenue, cash flow, expenses, etc. to provide the investors with an idea about the direction wherein the company is headed. The ratio tells you your average annual return.

The average annual growth rate is a calculation of the arithmetic mean of a series of growth rates. AAGR can be calculated for any investment, but it will not include any measure of the investment’s overall risk, as measured by its price volatility. Furthermore, the AAGR does not account for periodic compounding.

AAGR is a standard for measuring average returns of investments over several time periods on an annualized basis. You’ll find this figure on brokerage statements and in a mutual fund’s prospectus. It is essentially the simple average of a series of periodic return growth rates.

One thing to keep in mind is that the periods used should all be of equal length—for instance, years, months, or weeks—and not to mix periods of different duration.

AAGR Example

The AAGR measures the average rate of return or growth over a series of equally spaced time periods. As an example, assume an investment has the following values over the course of four years:

  • Beginning value = $100,000
  • End of year 1 value = $120,000
  • End of year 2 value = $135,000
  • End of year 3 value = $160,000
  • End of year 4 value = $200,000

The formula to determine the percentage growth for each year is:


Simple percentage growth or return = ending value beginning value 1 \text{Simple percentage growth or return} = \frac{\text{ending value}}{\text{beginning value}} – 1
Simple percentage growth or return=beginning valueending value1

Thus, the growth rates for each of the years are as follows:

  • Year 1 growth = $120,000 / $100,000 – 1 = 20%
  • Year 2 growth = $135,000 / $120,000 – 1 = 12.5%
  • Year 3 growth = $160,000 / $135,000 – 1 = 18.5%
  • Year 4 growth = $200,000 / $160,000 – 1 = 25%

The AAGR is calculated as the sum of each year’s growth rate divided by the number of years:


A A G R = 20 % + 12.5 % + 18.5 % + 25 % 4 = 19 % AAGR = \frac{20 \% + 12.5 \% + 18.5 \% + 25 \%}{4} = 19\%
AAGR=420%+12.5%+18.5%+25%=19%

In financial and accounting settings, the beginning and ending prices are usually used. Some analysts may prefer to use average prices when calculating the AAGR depending on what is being analyzed.

As another example, consider the five-year real gross domestic product (GDP) growth for the United States over the last five years. The U.S. real GDP growth rates for 2017 through 2021 were 2.3%, 2.9%, 2.3%, -3.4%, and 5.7%, respectively. Thus, the AAGR of U.S. real GDP over the last five years has been 1.96%, or (2.3% + 2.9% + 2.3% + -3.4% + 5.7%) / 5.

AAGR vs. Compound Annual Growth Rate

AAGR is a linear measure that does not account for the effects of compounding. The above example shows that the investment grew an average of 19% per year. The average annual growth rate is useful for showing trends; however, it can be misleading to analysts because it does not accurately depict changing financials. In some instances, it can overestimate the growth of an investment.

For example, consider an end-of-year value for year 5 of $100,000 for the AAGR example above. The percentage growth rate for year 5 is -50%. The resulting AAGR would be 5.2%; however, it is evident from the beginning value of year 1 and the ending value of year 5, the performance yields a 0% return. Depending on the situation, it may be more useful to calculate the compound annual growth rate (CAGR).

The CAGR smooths out an investment’s returns or diminishes the effect of the volatility of periodic returns. 

Formula for CAGR


C A G R = Ending Balance Beginning Balance 1 # Years 1 CAGR = \frac{\text{Ending Balance}}{\text{Beginning Balance}}^{\frac{1}{\text{\# Years}}} – 1
CAGR=Beginning BalanceEnding Balance# Years11

Using the above example for years 1 through 4, the CAGR equals:


C A G R = $ 200 , 000 $ 100 , 000 1 4 1 = 18.92 % CAGR = \frac{\$200,000}{\$100,000}^{\frac{1}{4}}- 1 = 18.92\%
CAGR=$100,000$200,000411=18.92%

For the first four years, the AAGR and CAGR are close to one another. However, if year 5 were to be factored into the CAGR equation (-50%), the result would end up being 0%, which sharply contrasts the result from the AAGR of 5.2%.

Limitations of the AAGR

Because AAGR is a simple average of periodic annual returns, the measure does not include any measure of the overall risk involved in the investment, as calculated by the volatility of its price. For instance, if a portfolio grows by a net of 15% one year and 25% in the next year, the average annual growth rate would be calculated to be 20%.

To this end, the fluctuations occurring in the investment’s return rate between the beginning of the first year and the end of the year are not counted in the calculations thus leading to some errors in the measurement.

A second issue is that as a simple average it does not care about the timing of returns. For instance, in our example above, a stark 50% decline in year 5 only has a modest impact on total average annual growth. However, timing is important, and so CAGR may be more useful in understanding how time-chained rates of growth matter.

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

The average annual growth rate (AAGR) identifies long-term trends of such financial measures as cash flows or investment returns. AAGR tells you what the annual return has been (on average), but it does not take into account compounding.

What Are the Limitations of Average Annual Growth Rate?

AAGR may overestimate the growth rate if there are both positive and negative returns. It also does not include any measure of the risk involved, such as price volatility—nor does it factor in the timing of returns.

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

Average annual growth rate (AAGR) is the average increase. It is a linear measure and does not take into account compounding. Meanwhile, the compound annual growth rate (CAGR) does and it smooths out an investment’s returns, diminishing the effect of return volatility.

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

The average annual growth rate (AAGR) is calculated by finding the arithmetic mean of a series of growth rates.

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Average Annual Return (AAR): Definition, Calculation, and Example

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Average Annual Return (AAR): Definition, Calculation, and Example

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What Is the Average Annual Return (AAR)?

The average annual return (AAR) is a percentage used when reporting the historical return, such as the three-, five-, and 10-year average returns of a mutual fund. The average annual return is stated net of a fund’s operating expense ratio. Additionally, it does not include sales charges, if applicable, or portfolio transaction brokerage commissions.

In its simplest terms, the average annual return (AAR) measures the money made or lost by a mutual fund over a given period. Investors considering a mutual fund investment will often review the AAR and compare it with other similar mutual funds as part of their mutual fund investment strategy.

Key Takeaways

  • The average annual return (AAR) is a percentage that represents a mutual fund’s historical average return, usually stated over three-, five-, and 10 years.
  • Before making a mutual fund investment, investors frequently review a mutual fund’s average annual return as a way to measure the fund’s long-term performance.
  • The three components that contribute to the average annual return of a mutual fund are share price appreciation, capital gains, and dividends.

Understanding the Average Annual Return (AAR)

When you are selecting a mutual fund, the average annual return is a helpful guide for measuring a fund’s long-term performance. However, investors should also look at a fund’s yearly performance to fully appreciate the consistency of its annual total returns.

For example, a five-year average annual return of 10% looks attractive. However, if the yearly returns (those that produced the average annual return) were +40%, +30%, -10%, +5% and -15% (50 / 5 = 10%), performance over the past three years warrants examination of the fund’s management and investment strategy.

Components of an Average Annual Return (AAR)

There are three components that contribute to the average annual return (AAR) of an equity mutual fund: share price appreciation, capital gains, and dividends.

Share Price Appreciation

Share price appreciation results from unrealized gains or losses in the underlying stocks held in a portfolio. As the share price of a stock fluctuates over a year, it proportionately contributes to or detracts from the AAR of the fund that maintains a holding in the issue.

For example, the American Funds AMCAP Fund’s top holding is Netflix (NFLX), which represents 3.7% of the portfolio’s net assets as of Feb. 29, 2020. Netflix is one of 199 equities in the AMCAP fund. Fund managers can add or subtract assets from the fund or change the proportions of each holding as needed to meet the fund’s performance objectives. The fund’s combined assets have contributed to the portfolio’s 10-year AAR of 11.58% through Feb. 29, 2020.

Capital Gains Distributions

Capital gains distributions paid from a mutual fund result from the generation of income or sale of stocks from which a manager realizes a profit in a growth portfolio. Shareholders can opt to receive the distributions in cash or reinvest them in the fund. Capital gains are the realized portion of AAR. The distribution, which reduces share price by the dollar amount paid out, represents a taxable gain for shareholders.

A fund can have a negative AAR and still make taxable distributions. The Wells Fargo Discovery Fund paid a capital gain of $2.59 on Dec. 11, 2015, despite the fund having an AAR of negative 1.48%.

Dividends

Quarterly dividends paid from company earnings contribute to a mutual fund’s AAR and also reduce the value of a portfolio’s net asset value (NAV). Like capital gains, dividend income received from the portfolio can be reinvested or taken in cash.

Large-cap stock funds with positive earnings typically pay dividends to individual and institutional shareholders. These quarterly distributions comprise the dividend yield component of a mutual fund’s AAR. The T. Rowe Price Dividend Growth Fund has a trailing 12-month yield of 1.36%, a contributing factor to the fund’s three-year AAR of 15.65% through Feb. 29, 2020.

Special Considerations

Calculating an average annual return is much simpler than the average annual rate of return, which uses a geometric average instead of a regular mean. The formula is: [(1+r1) x (1+r2) x (1+r3) x … x (1+ri)] (1/n) – 1, where r is the annual rate of return and n is the number of years in the period.

The average annual return is sometimes considered less useful for giving a picture of the performance of a fund because returns compound rather than combine. Investors must pay attention when looking at mutual funds to compare the same types of returns for each fund. 

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What Is Activity-Based Budgeting (ABB)? How It Works and Example

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What Is Activity-Based Budgeting (ABB)? How It Works and Example

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What is Activity-Based Budgeting (ABB)?

Activity-based budgeting (ABB) is a system that records, researches, and analyzes activities that lead to costs for a company. Every activity in an organization that incurs a cost is scrutinized for potential ways to create efficiencies. Budgets are then developed based on these results.

Activity-based budgeting (ABB) is more rigorous than traditional budgeting processes, which tend to merely adjust previous budgets to account for inflation or business development.

Key Takeaways

  • Activity-based budgeting (ABB) is a method of budgeting where activities that incur costs are recorded, analyzed and researched.
  • It is more rigorous than traditional budgeting processes, which tend to merely adjust previous budgets to account for inflation or business development.
  • Using activity-based budgeting (ABB) can help companies to reduce costs and, as a result, squeeze more profits from sales.
  • This method is particularly useful for newer companies and firms undergoing material changes.

How Activity-Based Budgeting (ABB) Works

Keeping costs to a minimum is a crucial part of business management. When done effectively and not too excessively, companies should be able to maintain and keep growing their revenues, while squeezing out higher profits from them.

Using activity-based budgeting (ABB) can help companies to reduce the activity levels required to generate sales. Eliminating unnecessary costs should boost profitability.

The activity-based budgeting (ABB) process is broken down into three steps.

  1. Identify relevant activities. These cost drivers are the items responsible for incurring revenue or expenses for the company.
  2. Determine the number of units related to each activity. This number is the baseline for calculations.
  3. Delineate the cost per unit of activity and multiply that result by the activity level.

Activity-Based Budgeting (ABB) Vs. Traditional Budgeting Processes

Activity-based budgeting (ABB) is an alternative budgeting practice. Traditional methods are more simplistic, adjusting prior period budgets to account for inflation or revenue growth. Rather than using past budgets to calculate how much a firm will spend in the current year, activity-based budgeting (ABB) digs deeper.

Activity-based budgeting (ABB) is not necessary for all companies. For example, established firms that experience minimal change typically find that applying a flat rate to data from the previous year to reflect business growth and inflation is sufficient.

In contrast, newer companies without access to historical budgeting information cannot consider this an option. Activity-based budgeting (ABB) is also likely to be implemented by firms undergoing material changes, such as those with new subsidiaries, significant customers, business locations, or products. In these types of cases, historical information may no longer be a useful basis for future budgeting.

Example of Activity-Based Budgeting

Company A anticipates receiving 50,000 sales orders in the upcoming year, with each single order costing $2 to process. Therefore, the activity-based budget (ABB) for the expenses relating to processing sales orders for the upcoming year is $100,000 ($50,000 * $2). 

This figure may be compared to a traditional approach to budgeting. If last year’s budget called for $80,000 of sales order processing expenses and sales were expected to grow 10%, only $88,000 ($80,000 + ($80,000 * 10%)) is budgeted.

Advantages and Disadvantages of Activity-Based Budgeting

Activity-based budgeting (ABB) systems allow for more control over the budgeting process. Revenue and expense planning occurs at a precise level that provides useful details regarding projections. ABB allows for management to have increased control over the budgeting process and to align the budget with overall company goals.

Unfortunately, these benefits come at a cost. Activity-based budgeting (ABB) is more expensive to implement and maintain than traditional budgeting techniques and more time consuming as well. Moreover, ABB systems need additional assumptions and insight from management, which can, on occasion, result in potential budgeting inaccuracies. 

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10-K: Definition, What’s Included, Instructions, and Where to Find it

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What Is a 10-K?

A 10-K is a comprehensive report filed annually by a publicly-traded company about its financial performance and is required by the U.S. Securities and Exchange Commission (SEC). The report contains much more detail than a company’s annual report, which is sent to its shareholders before an annual meeting to elect company directors.

Some of the information a company is required to document in the 10-K includes its history, organizational structure, financial statements, earnings per share, subsidiaries, executive compensation, and any other relevant data.

The SEC requires this report to keep investors aware of a company’s financial condition and to allow them to have enough information before they buy or sell shares in the corporation, or before investing in the firm’s corporate bonds.

Understanding 10-Ks

Because of the depth and nature of the information they contain, 10-Ks are fairly long and tend to be complicated. But investors need to understand that this is one of the most comprehensive and most important documents a public company can publish on a yearly basis. The more information they can gather from the 10-K, the more they can understand the company.

The government requires companies to publish 10-K forms so investors have fundamental information about companies so they can make informed investment decisions. This form gives a clearer picture of everything a company does and what kinds of risks it faces.

Investors in the know are aware that 10-Ks can also be retrieved by using the company search function through the SEC’s EDGAR database.

The 10-K includes five distinct sections:

  • Business. This provides an overview of the company’s main operations, including its products and services (i.e., how it makes money).
  • Risk factors. These outline any and all risks the company faces or may face in the future. The risks are typically listed in order of importance.
  • Selected financial data. This section details specific financial information about the company over the last five years. This section presents more of a near-term view of the company’s recent performance.
  • Management’s discussion and analysis of financial condition and results of operations. Also known as MD&A, this gives the company an opportunity to explain its business results from the previous fiscal year. This section is where the company can tell its story in its own words.
  • Financial statements and supplementary data. This includes the company’s audited financial statements including the income statement, balance sheets, and statement of cash flows. A letter from the company’s independent auditor certifying the scope of their review is also included in this section.

A 10-K filing also includes signed letters from the company’s chief executive officer and chief financial officer. In it, the executives swear under oath that the information included in the 10-K is accurate. These letters became a requirement after several high-profile cases involving accounting fraud following the dot-com bust.

Where to Find a 10-K

Notably, 10-K filings are public information and readily available through a number of sources. In fact, the vast majority of companies include them in the Investor Relations section of their website. The information included in a 10-K can be difficult to move through, but the more familiar investors become with the layout and the type of information included, it will likely become easier to identify the most important details.

Key Takeaways

  • A 10-K is a comprehensive report filed annually by public companies about their financial performance.
  • The report is required by the U.S. Securities and Exchange Commission (SEC) and is far more detailed than the annual report.
  • Information in the 10-K includes corporate history, financial statements, earnings per share, and any other relevant data.
  • The 10-K is a useful tool for investors to make important decisions about their investments.

10-K Filing Deadlines

Filing deadlines for the 10-K vary based on the size of the company. According to the SEC, companies with a public float—shares issued to the public that are available to trade—of $700 million or more must file their 10-K within 60 days after the end of their fiscal year. Companies with a float between $75 million and $700 million have 75 days, while companies with less than $75 million in their float have 90 days.

Forms 10-Q and 8-K

Along with the 10-K, the SEC requires that public companies regularly file forms 10-Q and 8-K.

Form 10-Q must be submitted to the SEC on a quarterly basis. This form is a comprehensive report of a company’s performance and includes relevant information about its financial position. Unlike the 10-K, the information in the 10-Q is usually unaudited. The company is only required to file it three times a year as the 10-K is filed in the fourth quarter.

The form 8-K though is required by the SEC whenever companies announce major events of which shareholders must be made aware. These events may include (but aren’t limited to) sales, acquisitions, delistings, departures, and elections of executives, as well as changes in a company’s status or control, bankruptcies, information about operations, assets, and any other relevant news.

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