What is the Sustainable Growth Rate Formula?
Sustainable growth rate (SGR) signifies how much the company can grow sustainably in the future without relying on external capital infusion in the form of debt or equity and is calculated using the return on equity (which is the rate of return on the book value of equity) and multiplying it by the business retention rate (which the proportion of earnings kept back in the business as retained earnings).
- Return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit. is the percentage of earnings for a period of a company with respect to the equity invested in the company. Return on equity is arrived at by dividing earnings from equity.
- The Retention ratioRetention RatioRetention ratio indicates the percentage of a company’s earnings which is not paid out as dividends but credited back as retained earnings. This ratio highlights how much of the profit is being retained as profits towards the development of the firm. is the percentage of earnings that the company retains for its use and future growth of the company. The retention amount is the residual amount after the amount paid from earnings as a dividend.
- RR= Retention ratio
- ROE= Return on Equity
It is the operational growth rate achieved without taking into consideration the borrowed funds in the form of debt by the company. That’s why this ratio is considered to be sustainable as this much the company will be able to grow even without taking any outside debt investments.
It is the growth achieved by a company with the help of the earnings it decides to retain after distributing the amount of money the shareholders in the form of a dividend. An analyst looking at a sustainable growth rate ratio will look for a higher ratio as it signifies a better future prospect for the company.
Examples of Sustainable Growth Rate Formula (with Excel Template)
Let’s see some simple to advanced examples to understand it better.
Let’s assume some numbers in the table below to calculate the sustainable growth for two companies. Calculate the sustainable growth rate for these two arbitrary companies.
|Earning Per Share||$4||$5|
|Dividends Per Share||1.5||2|
|Return on Equity||14%||10%|
For the calculation of a sustainable growth rate, we need the return on equity of a company and retention ratio, which is calculated by deducting the dividend amount payableDividend Amount PayableDividend payable is that portion of accumulated profits that is declared to be paid as dividend by the company's board of directors. Until the dividend declared is paid to the concerned shareholders, the amount is recorded as a dividend payable in the head current liability. from the earnings of the company and dividing that numerator by net income available to the shareholders.
Retention ratio for Company A
RR= 1- (dividends paid/earnings)
- Retention ratio for Company A= 1- (1.5/4)= 0.63
Retention Ratio for Company B
- Retention ratio for Company B= 1- (2/5) = 0.60
Therefore the calculation of the Sustainable Growth Rate equation for company A is as follows,
- Sustainable growth for company A = 14%*.63
Sustainable Growth Rate for company A
- Sustainable growth for company A= 8.8%
Therefore the calculation of Sustainable growth rate for company B is as follows,
- Sustainable growth for company B = 10%*0.60
Sustainable Growth Rate for Company B
- Sustainable growth for company B= 6.0%
Calculate the Sustainable growth rate for Reliance Industries. The table below depicts the dividend, earnings per share, and the return on equity for reliance industries.
|Earnings Per Share||Rs 56|
|Dividends Per Share||6|
|Return on Equity||12%|
Retention Ratio for Reliance Industries
- Retention ratio for Reliance Industries = 1- (6/56) =0.89
Therefore the calculation of the SGR formula is as follows,
- Sustainable growth for Reliance Industries = 12%*.89
The sustainable growth rate for Reliance Industries
- Sustainable growth for Reliance Industries = 11%
The higher the rate of Sustainable growth better it is for the company; the ratio signifies for a company that how much the company can grow sustainably in the future with the number of earnings it is generated with the help of the normal course of business. The ratio for reliance industries signifies that reliance industries are able to grow by 11% on a sustainable basis in the future.
The table below depicts the dividend, earnings per shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is., and the return on equity for Tata Steel.
|Earnings Per Share||Rs 75|
|Dividends Per Share||9.4|
|Return on Equity||23%|
Retention ratio for Tata Steel
- Retention ratio for Tata Steel = 1- (9.4/75) =.87
Therefore the calculation of the SGR formula is as follow,
- The sustainable growth for Tata Steel = 23%*0.87
The SGR for Tata Steel
- The sustainable growth for Tata Steel = 20%
The higher the rate of SGR better it is for the company; the ratio signifies for a company that how much the company can grow sustainably in the future with the number of earnings it is generated with the help of the normal course of business. The ratio for Tata Steel signifies that Tata Steel is able to grow by 20% on a sustainable basis in the future.
Sustainable Growth Rate Calculator
You can use the following SGR Formula Calculator.
|Sustainable Growth Rate Formula =||Retention Ratio x Return on Equity|
|0 x 0 =||0|
Relevance and Uses
Sustainable growth is a critical ratio to find out the future prospect of a company. Analysts who analyze the company keep a very close look at the ratio. The ratio is arrived at by using two vital parameters, which the return for the equity shareholders of the company. And the second variable used for calculating the SGR Formula is the retention ratio.
It is desirable to have both a higher ratio for return on equity as that signifies higher earnings on the same level of equity investments and also a higher level of retention ratio. If a company is maintaining a higher level of retention ratio, it signifies that the company has future growth prospects and is confident of generating a higher return with the money it is willing to retain. The reason for which return on equity is used as a variable for the ratio is that it directs towards the operational growth of the company, which is attained without the use of financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. .
This article has been a guide to Sustainable Growth Rate Formula. Here we discuss how to calculate Sustainable Growth Rate along with some practical examples and a downloadable excel template. You may learn more about Valuation Analysis from the following articles –