How to Calculate Future Growth Rate of a Company

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Future Growth Rate Calculator

Calculation Results:

Return on Equity (ROE): 0%

Retention Ratio: 0%

Estimated Future Growth Rate: 0%

*This represents the Sustainable Growth Rate (SGR) based on current financial efficiency and plowback policy.

function calculateGrowthRate() { var netIncome = parseFloat(document.getElementById('netIncome').value); var equity = parseFloat(document.getElementById('shareholdersEquity').value); var dividends = parseFloat(document.getElementById('dividendsPaid').value); if (isNaN(netIncome) || isNaN(equity) || isNaN(dividends) || equity <= 0 || netIncome <= 0) { alert("Please enter valid positive numbers for Net Income and Equity."); return; } // 1. Calculate ROE (Return on Equity) var roe = (netIncome / equity); // 2. Calculate Retention Ratio (Plowback Ratio) // Retention Ratio = (Net Income – Dividends) / Net Income var retentionRatio = (netIncome – dividends) / netIncome; if (retentionRatio < 0) { alert("Dividends cannot exceed Net Income for this calculation model."); return; } // 3. Calculate Sustainable Growth Rate // g = ROE * Retention Ratio var growthRate = roe * retentionRatio; document.getElementById('roeValue').innerText = (roe * 100).toFixed(2); document.getElementById('retentionValue').innerText = (retentionRatio * 100).toFixed(2); document.getElementById('finalGrowthRate').innerText = (growthRate * 100).toFixed(2); document.getElementById('growthResult').style.display = 'block'; }

Understanding the Future Growth Rate of a Company

Predicting the future growth rate of a company is a cornerstone of fundamental analysis. Whether you are performing a Discounted Cash Flow (DCF) valuation or comparing stocks, knowing how fast a company can expand without taking on excessive debt is critical for long-term investment success.

What is the Sustainable Growth Rate (SGR)?

The Sustainable Growth Rate (SGR) is the maximum rate of growth a company can maintain without having to finance expansion with additional equity or debt. It is calculated by looking at how much profit the company generates relative to its equity and how much of that profit is reinvested back into the business instead of being paid out as dividends.

The Growth Rate Formula

To calculate the future growth rate using the fundamental method, we use the following formula:

Growth Rate (g) = Return on Equity (ROE) × Retention Ratio

1. Return on Equity (ROE)

ROE measures how effectively management is using the company's assets to create profits. It is calculated as Net Income / Shareholders' Equity. A higher ROE suggests a more efficient company capable of generating more internal capital for growth.

2. Retention Ratio

Also known as the "Plowback Ratio," this represents the portion of earnings kept in the company to fund operations and expansion. If a company pays out 30% of its earnings as dividends, its retention ratio is 70% (0.70).

Example Calculation

Let's look at a realistic scenario for a mid-sized technology firm:

  • Net Income: 1,000,000
  • Shareholders' Equity: 5,000,000
  • Dividends Paid: 200,000

Step 1: Calculate ROE
ROE = 1,000,000 / 5,000,000 = 20% (0.20)

Step 2: Calculate Retention Ratio
Earnings Retained = 1,000,000 – 200,000 = 800,000
Retention Ratio = 800,000 / 1,000,000 = 80% (0.80)

Step 3: Calculate Future Growth Rate
Growth Rate = 20% × 80% = 16%

In this example, the company can grow its earnings by 16% per year using its own internally generated funds.

Factors That Influence Growth

While the SGR provides a mathematical baseline, several external and internal factors can shift the actual growth trajectory:

  • Profit Margins: If a company improves its operational efficiency, its Net Income rises, boosting ROE and potential growth.
  • Asset Turnover: How efficiently the company uses its assets to generate sales impacts overall profitability.
  • Market Saturation: Even with a high retention ratio, a company cannot grow if the market for its product is already full.
  • Capital Structure: Increasing debt (leverage) can temporarily boost ROE, but it also increases financial risk.

Limitations of this Model

Investors should remember that the Sustainable Growth Rate assumes the company's capital structure and dividend policy remain constant. In the real world, companies often change their dividend payouts or issue new shares, which can deviate from the calculated SGR. It is best used as a "sanity check" against overly optimistic analyst forecasts.

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