Equation and meaning
What is Sustainable Growth Rate?
The sustainable growth rate (SGR) is the maximum rate at which a company can grow its sales, earnings, and dividends without increasing its financial leverage or relying on external equity. It assumes the company maintains a constant capital structure and retains a fixed portion of earnings.
Formula for Sustainable Growth Rate
The formula is:
SGR = Return on Equity (ROE) × Retention Ratio
Where:
- ROE = Net Income / Shareholders' Equity
- Retention Ratio = 1 - Dividend Payout Ratio
How to Calculate Sustainable Growth Rate
- Calculate ROE: Divide net income by shareholders' equity.
- Determine the retention ratio: Subtract the dividend payout ratio from 1.
- Multiply ROE by the retention ratio to get SGR.
Example
Suppose a company has net income of $100,000 and shareholders' equity of $500,000. Its ROE is 20%. If it pays out 30% of earnings as dividends, the retention ratio is 70%. Thus, SGR = 20% × 70% = 14%.
Limitations
SGR assumes constant profitability and dividend policy, which may not hold in reality. It also ignores potential changes in capital structure or external financing.
Frequently asked questions
What is the sustainable growth rate formula?
The sustainable growth rate (SGR) is calculated as Return on Equity (ROE) multiplied by the retention ratio (1 - dividend payout ratio).
How do you calculate sustainable growth rate?
To calculate SGR, first determine ROE (net income divided by shareholders' equity) and the retention ratio (earnings retained after dividends). Then multiply ROE by the retention ratio.
What does sustainable growth rate indicate?
SGR indicates the maximum growth rate a company can achieve without external financing while maintaining a constant debt-to-equity ratio.
Related ExamElite resources
Variables in this formula
ROE — RoeRR — RrSustainable_growth_rate — Sustainable Growth Rate