Sustainable Growth Rate Calculator
Our sustainable growth rate calculator will help you find the sustainable growth rate (SGR) for any company you wish. This metric will help you assess and compare the growth rate of different companies.
This article will explain what the sustainable growth rate is and how to calculate it using the sustainable growth rate formula. Furthermore, we will help you understand this concept by showing you some practical examples.
What is the sustainable growth rate? The sustainable growth rate meaning
The sustainable growth rate (SGR) is defined as the maximum growth rate a company can achieve without getting funding from equity and debt. The sustainable growth rate consists of a company's retention rate multiplied by its returns on equity. Mathematically, it is understood as the **the value the company can generate with the amount of money it retains.
The SGR formula is most commonly used in various valuation models, such as the dividend discount model (DDM), discounted cash flow model, etc. Hence, it is crucial for us to understand the underlying meaning of this concept.
How does the sustainable growth rate calculator work?
Let's look at Company Alpha, which contains the following information, as an example explaining the SGR formula:
- Name: Company Alpha
- Net income: $2,000,000
- Dividends paid: $1,000,000
- Shareholders' equity: $10,000,000
The SGR calculation requires 3 steps:
- Calculate the retention ratio
The retention ratio is the number of earnings the company retains after paying out its dividends. We can calculate it using the formula below:
retention ratio = 1 - dividends paid / net income
retention ratioof Company Alpha is
1 - $1,000,000 / $2,000,000 = 50%.
- Calculate the return on equity (ROE)
The next step is to calculate the
ROEusing the formula below:
ROE = net income / shareholders' equity
With this formula, the Company Alpha's ROE is
$2,000,000 / $10,000,000 = 20%.
- Calculate the sustainable growth rate (SGR)
SGRcan be calculated using the sustainable growth rate formula:
SGR = retention ratio * ROE.
Hence, Company Alpha's
50% * 20% = 10%.
Remember that you can always use our sustainable growth rate calculator to quickly obtain the same result.
Understanding the sustainable growth rate (SGR)
Now that we have got the calculation out of the way and learned what SGR meaning is, let's talk about some insights when applying this metric:
It is difficult for companies to maintain a high sustainable growth rate as they need to make investments to grow. For instance, companies often need to spend millions in research and development to discover new products. This can significantly impact the company's ROE, hence affecting the SGR. Moreover, changes in economic conditions can also affect the sustainable growth rate.
Furthermore, you might want to pay extra attention to a company's financial leverage when analyzing its sustainable growth rate. This is because some companies may increase their financial leverage with the sole purpose of propping up their ROE, thus increasing their sustainable growth rate. This is considered a negative signal as the SGR is not sustainable under these circumstances.
Can the sustainable growth rate be negative?
Yes, mathematically the sustainable growth rate can be negative.
This will happen when the net income of the company is negative, causing the company's ROE to be negative. Since ROE is part of the sustainable growth rate equation, this will make it negative.
What is the main limitation of the sustainable growth rate?
The sustainable growth rate (SGR) is not useful in analyzing high-growth companies. These companies usually make huge investments to increase their market share. This can negatively impact their net income and ROE, which sometimes makes their SGR low.
What is a good sustainable growth rate?
There is no hard number to determine if the company's sustainable growth rate (SGR) is good or bad. However, a common way to assess this is to compare the SGR to the GDP (gross domestic product) growth rate of the country in which the company is based.
An SGR that is higher than the GDP growth rate indicates that the company outperforms the economy.
Why is sustainable growth rate useful?
The sustainable growth rate is useful to assess a company's growth trajectory. Besides that, the sustainable growth rate also acts as an important input in various valuation models, such as the dividend discount model, discounted cash flow (DCF) model, etc.