Sustainable growth rate
What is a sustainable growth rate?
It’s a measure of how much growth a company can achieve using only its own sources of funding. Growth is seen as a good thing, but it needs to be sustainable. Runaway growth can make it harder for a business to get financing to sustain that growth. On the other hand, a business that grows too slowly will stagnate.
Where have you heard about sustainable growth rates?
Achieving a sustainable growth rate (SGR) is every company's goal, but that’s easier said than done. Factors such as a reduction in consumer spending and lack of an effective planning strategy can scupper a firm’s ability to achieve its optimal SGR.
What you need to know about sustainable growth rates.
To calculate the SGR for a company, you first need to determine the return on equity (ROE) it generates. This is the amount of net income that’s produced for a whole year using the money that shareholders have invested in the firm.
You then determine the dividend cover, which shows how many times over the profits could have paid the dividend. That's calculated by dividing dividends per share by earnings per share.
The formula for working it out is: SGR = (1-dividend cover) x ROE.