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Sustainable Growth Rate

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When referencing a company's sustainable growth rate, an analyst is discussing the growth in earnings and dividends that can be maintained given a company's ROE and its existing capital structure.

gsustainable = b × ROE

  • b = earnings retention rate = (1 - dividend payout rate)

  • CFA may present candidates with a problem that requires a growth rate value, but fail to provide that growth rate value. However, it may provide ROE and either the retention rate or payout rate. If that is the case, then use the above formula to derive the growth rate and solve the problem.

  • The DuPont method for ROE can also be used to derive a company's sustainable growth rate - hopefully by now you have picked up that the DuPont ROE is a concept that CFAI is likely to test on the exam.

g = (Net Inc. / Sales) × ((Net Inc. - Div.) / Net Inc.) × (Net Revenue / Avg. Total Assets) × (Avg. Total Assets / Avg. Shareholders Equity)

g = Net Profit Margin × Retention Ratio × Asset Turnover × Financial Leverage

  • Note this formula references average values; if the test question only provides you with one value (as two is required to create an average) simply use what is provided.
Previous Lesson

H-Model for Valuing Growth

01
Equity Analysis Part 2 - Introduction
02
Porter’s Five Competitive Forces
03
Industry Analysis
04
Supply and Demand Analysis
05
Financial Projections in Emerging Markets
06
Cost of Capital in Emerging Markets
07
Cash Flows: Dividends vs. Free Cash Flows vs. Residual Income
08
Dividend Discount Model (DDM)
09
Gordon Growth Model (GGM)
10
Present Value of Growth Opportunities (PVGO)
11
GGM, Leading P/E Ratio, and Trailing P/E Ratio
12
Multi-Stage Dividend Discount Models
13
H-Model for Valuing Growth
14
Sustainable Growth Rate

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