DCF Growth Rate Calculator
Calculate the Sustainable Growth Rate (SGR) or Historical CAGR for your valuation models.
1. Sustainable Growth Rate (SGR)
Based on fundamental company performance.
2. Historical CAGR
Based on historical financial trends.
How to Calculate Growth Rate for DCF
In a Discounted Cash Flow (DCF) analysis, the growth rate is one of the most sensitive variables. It determines how much Free Cash Flow (FCF) a business will generate in the future and dictates the final Terminal Value. There are two primary ways to estimate this: the Fundamental Approach and the Historical Approach.
1. The Sustainable Growth Rate (Fundamental)
This method looks at how much profit a company reinvests back into itself and how efficiently it earns a return on that capital. It is widely considered more "intellectually honest" than just looking at the past.
Formula: Growth Rate = Return on Equity (ROE) × Retention Ratio
- ROE: Net Income divided by Shareholder Equity. It represents profitability.
- Retention Ratio: The percentage of earnings kept by the company (1 – Dividend Payout Ratio).
2. Historical CAGR Method
This method calculates the geometric mean growth rate over a specific period. While past performance does not guarantee future results, it provides a baseline for what the company has achieved under current management.
Formula: CAGR = [(Ending Value / Beginning Value) ^ (1 / n)] – 1
Growth Rate Examples in DCF
| Metric | Conservative | Aggressive |
|---|---|---|
| ROE | 10% | 20% |
| Retention | 30% | 80% |
| Implied Growth | 3.0% | 16.0% |
Critical Considerations for DCF Models
- Terminal Growth Rate: This should rarely exceed the long-term growth rate of the economy (typically 2% to 3%). If a company grows faster than the GDP forever, it would eventually become the entire economy.
- Stage 1 vs. Stage 2: High-growth companies often have a 5-10 year period of high growth (Stage 1) followed by a transition to stable, lower growth (Stage 2).
- Reinvestment: High growth requires capital. Ensure your FCF projections account for the Capital Expenditures (CapEx) needed to fuel that growth.