The sustainable growth rate (SGR) of a Company
The sustainable growth rate (SGR) is the maximum rate of growth that a company or social enterprise can sustain without having to finance growth with additional equity or debt. The SGR involves maximizing sales and revenue growth without increasing financial leverage. Achieving the SGR can help a company prevent being over-leveraged and avoid financial distress.
Predictions Made by Analysts
Some investors find company analysis frustrating and tend to read through some analysts’ findings. Many equity analysts offer predictions about the expected growth rate of a company by sifting through volumes of data and information. However, it is important to remember that while these analysts are experts in their field, their predictions can be way off the mark. Hence, this should be considered as a good piece of information but not enough to make investment decisions.
Historical earnings per share (EPS) Performance
Another way used by investors to gauge the growth prospects of a company is by looking at its growth over the last decade. They use this data to extrapolate into the future. This can be counterproductive too because as the company grows, it becomes increasingly difficult to maintain its rate of growth. Hence, while the historical EPS performance can be a good way to assess the growth of the company to date while estimating its potential, it is important to consider the fact that as the company grows, its growth rate tends to shrink.
Return on Equity
Some investors use Return on Equity (RoE) as an indicator of the growth of the company. So, a company with a history of constantly increasing RoE is usually perceived as one with good growth potential.
Sustainable Growth Rate Calculation
To accurately assess the growth potential of a company, we will first look at the Sustainable Growth Rate which is the maximum rate at which a company can grow without taking on more debt. This is important because as an investor, you would want to invest in a company that can fund its growth with its earnings. The formula to calculate it is as follows:
Sustainable Growth Rate = Return on Equity x (1 – Dividend Payout Ratio)
In simpler terms, this formula takes the RoE ratio and makes adjustments for dividends paid out by the company. This gives you a clearer picture of the expected growth rate.
However, the Sustainable Growth Rate is the maximum rate at which the company can grow. As an investor, you would be more interested in the realistic rate as opposed to the maximum rate. And so, Sustainable Growth Rate is not ideal either.
