What is a Sustainable Growth Rate?
The sustainable growth rate represents how quickly a company can expand using only its own sources of funding.
How to calculate Sustainable Growth Rate
A company's sustainable growth rate is expressed mathematically in the following way:
In other words, a sustainable growth rate is the product of a company's return on equity and the portion of its earnings that are remaining after dividends have been paid. For instance, a company with a 10% percent return on equity and a dividend payout ratio of 30% would have a sustainable growth rate of 0.1 * (1-0.30) = 0.07, which comes out to 7.0%. This means that using only the revenue it generates, this company can grow at a 7 percent annual pace.
Why do Sustainable Growth Rates matter?
A company's sustainable growth rate is its growth ceiling assuming the contribution of its own resources. In order to grow more rapidly beyond this ceiling, a company must borrow money or raise additional funds through the issuance of equity or debt securities.