How to Calculate Future Growth Rate of a Stock

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Stock Future Growth Rate Calculator

Estimated Sustainable Growth Rate:

function calculateStockGrowth() { var netIncome = parseFloat(document.getElementById('netIncome').value); var dividends = parseFloat(document.getElementById('dividendsPaid').value); var equity = parseFloat(document.getElementById('shareholdersEquity').value); if (isNaN(netIncome) || isNaN(dividends) || isNaN(equity) || equity <= 0 || netIncome <= 0) { alert("Please enter valid positive numerical values. Equity and Net Income must be greater than zero."); return; } // Retention Ratio = (Net Income – Dividends) / Net Income var earningsRetained = netIncome – dividends; var retentionRatio = earningsRetained / netIncome; // ROE = Net Income / Shareholders' Equity var roe = netIncome / equity; // Sustainable Growth Rate = Retention Ratio * ROE var growthRate = (retentionRatio * roe) * 100; var resultContainer = document.getElementById('growthResultContainer'); var resultDisplay = document.getElementById('growthResult'); var logicDisplay = document.getElementById('logicBreakdown'); resultDisplay.innerHTML = growthRate.toFixed(2) + "%"; var breakdownHtml = "Detailed Breakdown:"; breakdownHtml += "• Retention Ratio (b): " + (retentionRatio * 100).toFixed(2) + "% of earnings are kept by the company."; breakdownHtml += "• Return on Equity (ROE): " + (roe * 100).toFixed(2) + "% efficiency in generating profit from equity."; breakdownHtml += "• Formula: Growth = Retention Ratio × ROE"; logicDisplay.innerHTML = breakdownHtml; resultContainer.style.display = "block"; }

How to Calculate the Future Growth Rate of a Stock

Understanding the future growth potential of a company is critical for value investors. While no one can predict the exact future, the Sustainable Growth Rate (SGR) provides a realistic estimate based on a company's fundamental financial health. It tells you how fast a company can grow without needing to take on additional debt or issue more equity.

The Fundamental Formula

The standard model for calculating future growth based on fundamentals is:

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

Key Components Defined

  • Retention Ratio: This is the percentage of net income that is reinvested back into the business instead of being paid out as dividends. If a company earns $100 and pays $20 in dividends, it retains $80, giving it a retention ratio of 80% (0.80).
  • Return on Equity (ROE): This measures how effectively management uses shareholders' capital to generate profit. It is calculated as Net Income divided by Shareholders' Equity.

Real-World Example

Imagine a tech company, ExampleCorp, with the following financials:

  • Net Income: $5,000,000
  • Dividends Paid: $1,000,000
  • Shareholders' Equity: $25,000,000

Step 1: Calculate Retention Ratio.
($5,000,000 – $1,000,000) / $5,000,000 = 0.80 (80%)

Step 2: Calculate Return on Equity (ROE).
$5,000,000 / $25,000,000 = 0.20 (20%)

Step 3: Calculate Sustainable Growth Rate.
0.80 × 0.20 = 0.16 or 16%

This means that if ExampleCorp maintains its current efficiency and reinvestment policy, it can grow its earnings by 16% per year using its own resources.

Why This Matters for Investors

If a company is trading at a price-to-earnings (P/E) ratio that assumes a 30% growth rate, but the sustainable growth rate is only 10%, the stock may be overvalued. Conversely, a company with a high retention ratio and high ROE is a compounding machine that can create significant long-term wealth for shareholders.

Note: This calculator assumes that the company's capital structure (debt-to-equity) remains constant and that the ROE is sustainable over the long term.

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