Sustainable growth rate
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Sustainable growth rate (SGR) is the maximum rate at which a company can grow revenue without having to invest new equity capital. If a company earns a 15% return on equity (ROE), it can grow 15% simply by reinvesting all the earnings in new opportunities and maintaining a stable debt to equity ratio. In order to grow faster, the company would have to invest more equity capital or increase its financial leverage.
Although companies can grow at extremely rapid rates for some time, such growth cannot typically be sustained. Valuation methods such as the Gordon model and other discounted cash flow models require a growth estimate than can be sustained for many years. Since sales growth is not necessarily profitable, in order to grow equity rather than issue it, ROE should be positive.
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[edit] Basic formula
SGR = ROE * (1 – Dividend payout ratio)[1]
[edit] SGR assumptions
- the company grows sales as rapidly as market conditions permit;
- the company maintains its existing asset turnover and profitability;
- management is unwilling to issue new equity;
- the company maintains it current capital structure and dividend policy;
- ROE can be split via DuPont Model for further analysis.
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