How to Calculate Expected Earnings Growth Rate

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Expected Earnings Growth Rate Calculator

Results

Retention Ratio: 0%

Expected Earnings Growth Rate: 0%

This represents the sustainable growth rate based on internal reinvestment.

function calculateEarningsGrowth() { var roeValue = document.getElementById("inputROE").value; var epsValue = document.getElementById("inputEPS").value; var dpsValue = document.getElementById("inputDPS").value; if (roeValue === "" || epsValue === "" || dpsValue === "" || parseFloat(epsValue) === 0) { alert("Please enter valid numbers. EPS cannot be zero."); return; } var roe = parseFloat(roeValue) / 100; var eps = parseFloat(epsValue); var dps = parseFloat(dpsValue); // Calculate Retention Ratio (b) = (EPS – DPS) / EPS var retentionRatio = (eps – dps) / eps; // Expected Growth Rate (g) = ROE * b var growthRate = roe * retentionRatio * 100; document.getElementById("resRetention").innerText = (retentionRatio * 100).toFixed(2); document.getElementById("resGrowth").innerText = growthRate.toFixed(2); document.getElementById("growthResultBox").style.display = "block"; }

How to Calculate Expected Earnings Growth Rate

The Expected Earnings Growth Rate (also known as the Sustainable Growth Rate) is a critical metric used by fundamental investors and analysts to estimate how fast a company's bottom line can expand without seeking outside financing. It focuses on the capital the company generates and chooses to keep.

The Formula

The primary way to calculate expected earnings growth is through the retention ratio and profitability:

Expected Growth Rate = ROE × Retention Ratio

Key Components:

  • Return on Equity (ROE): This measures how effectively a company uses shareholder capital to generate profit. It is calculated as Net Income / Shareholder's Equity.
  • Retention Ratio: This is the percentage of earnings a company keeps after paying out dividends. It is calculated as 1 – (Dividends / Net Income) or (EPS – DPS) / EPS.

Step-by-Step Example

Suppose "Alpha Corp" has the following financials:

  • ✅ ROE: 20% (0.20)
  • ✅ EPS: $4.00
  • ✅ Dividends: $1.00
  1. Find the Retention Ratio: ($4.00 – $1.00) / $4.00 = 0.75 (or 75%). This means the company reinvests 75% of its profits back into operations.
  2. Apply the Formula: 0.20 (ROE) × 0.75 (Retention) = 0.15.
  3. Result: The expected earnings growth rate is 15%.

Why It Matters for Investors

The expected growth rate helps determine the intrinsic value of a stock. In valuation models like the Gordon Growth Model or a Discounted Cash Flow (DCF) analysis, the terminal growth rate is often capped by this sustainable growth figure. If a company has a high ROE and a high retention ratio, it possesses the "engine" to grow earnings rapidly without diluting shareholders or taking on excessive debt.

Pro Tip: Be cautious if the calculated growth rate is significantly higher than the overall GDP growth for a long-term terminal value. While companies can grow at 20%+ in the short term, perpetual growth usually stabilizes between 2% and 4%.

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