sustainable growth rate

(noun)

the optimal growth from a financial perspective assuming a given strategy with clear defined financial frame conditions/ limitations

Related Terms

Examples of sustainable growth rate in the following topics:

  • Assessing Internal Growth and Sustainability

    • Sustainable-- as opposed to internal-- growth gives a company a better idea of its growth rate while keeping in line with financial policy.
    • What is its sustainable growth rate?
    • Sustainable Growth Rate = (750,000/5,000,000) x (1-0.80).
    • Sustainable Growth Rate = 3%
    • Therefore, a more commonly used measure is the sustainable growth rate.

  • Relationships between ROA, ROE, and Growth

    • What is the company's ROA and internal growth rate?
    • What is the company's ROE and sustainable growth rate?
    • ROA = 500,000/3,000,000 = 17% Internal growth rate = 17% x 80% = 13% ROE = 17% x (3,000,000/1,500,000) = 34% Sustainable growth rate = 34% x 80% = 27.2%
    • In terms of growth rates, we use the value known as return on assets to determine a company's internal growth rate.
    • We use the value for return on equity, however, in determining a company's sustainable growth rate, which is the maximum growth rate a firm can achieve without issuing new equity or changing its debt-to-equity ratio.

  • Valuing Nonconstant Growth Dividends

    • When a stock has a significantly higher growth rate than its peers, it is sometimes assumed that the earnings growth rate will be sustained for a short time (say, 5 years), and then the growth rate will revert to the mean.
    • This gives you an estimate of the "break-even" growth rate for the stock's current P/E ratio.
    • Subsequently, one can divide this imputed growth estimate by recent historical growth rates.
    • If the resulting ratio is less than one, it implies that either the market expects growth to slow for this stock or that the stock could sustain its current P/E with lower than historical growth (lower values suggest potential undervaluation).
    • Describe the limitations of valuing a company with dividends that have a nonconstant growth rate

  • Price/Earnings Ratio

    • The price is in currency per share, while earnings are in currency per share per year, so the P/E ratio shows the number of years of earnings that would be required to pay back the purchase price, ignoring inflation, earnings growth, and the time value of money.
    • Stocks with higher (or more certain) forecast earnings growth will usually have a higher P/E, and those expected to have lower (or riskier) earnings growth will usually have a lower P/E.
    • Investors can use the P/E ratio to compare the value of stocks; for example, if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment.
    • In turn, the primary driver for multiples such as the P/E ratio is through higher and more sustained earnings growth rates.
    • Conversely, companies with low P/E ratios may be tempted to acquire small high growth businesses in an effort to "rebrand" their portfolio of activities and burnish their image as growth stocks and thus obtain a higher P/E rating.

  • Expected Dividends and Constant Growth

    • Valuations rely heavily on the expected growth rate of a company; past growth rate of sales and income provide insight into future growth.
    • Valuations rely very heavily on the expected growth rate of a company.
    • One must look at the historical growth rate of both sales and income to get a feeling for the type of future growth expected.
    • Calculating the future growth rate requires personal investment research.
    • It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever.

  • Central Banks

    • Therefore, the Fed can indirectly affect the interest rates, exchange rates, inflation, and the output growth rate of the U.S. economy.
    • Variable 1: Inflation is a sustained rise in the average prices for goods and services of an economy.
    • Although inflation erodes the value of money, a low inflation rate is not necessarily bad because it might indicate economic growth.
    • Usually economists refer to "the interest rate," because interest rates move together.
    • One important function of monetary policy is to create economic growth.

  • Macroeconomic Factors Influencing the Interest Rate

    • Taylor explained the rule of determining interest rates using three variables: inflation rate, GDP growth, and the real interest rate.
    • An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender in the market.
    • In this equation, it is the target short-term nominal interest rate (e.g., the federal fund rates in the United States), πt is the rate of inflation as measured by the GDP deflator, π*t is the desired rate of inflation, r*t is the assumed equilibrium real interest rate, yt is the logarithm of real GDP, and y*t is the logarithm of potential output, as determined by a linear trend.
    • If this calculation yields a positive number, it is called an "inflationary gap" and indicates the growth of aggregate demand is outpacing the growth of aggregate supply (or high level of employment), possibly creating inflation, signaling an increase in interest rates made by the Central Bank; if the calculation yields a negative number it is called a "recessionary gap," which is accompanied by a low employment rate, possibly signifying deflation and a reduction in interest rates.
    • Taylor explained the rule in simple terms using three variables: inflation rate, GDP growth, and the equilibrium real interest rate.

  • Relationship Between Dividend Payments and the Growth Rate

    • The portion of the earnings not paid to investors is, ideally, left for investment in order to provide for future earnings growth.
    • These companies also provide limited growth opportunities, since earnings are not reinvested for the purpose of growth.
    • On the other hand, some companies can retain earnings and put that money back to work - i.e., invest in growth opportunities.
    • Put succinctly, investors seeking high current income and limited capital growth prefer companies with a high dividend payout ratio.
    • However, investors seeking higher capital growth may prefer a lower payout ratio because capital gains are taxed at a lower rate.

  • Calculating Perpetuities

    • The PV is simply the payment size (A) divided by the interest rate (r).
    • It is also possible that an annuity has payments that grow at a certain rate per period.
    • The rate at which the payments change is fittingly called the growth rate (g).
    • It is essentially the same as in except that the growth rate is subtracted from the interest rate.
    • Another way to think about it is that for a normal perpetuity, the growth rate is just 0, so the formula boils down to the payment size divided by r.

  • Disinflation

    • Disinflation is a decrease in the inflation rate; a slowdown in the rate of increase of the general price level of goods, services.
    • Disinflation is a decrease in the rate of inflation–a slowdown in the rate of increase of the general price level of goods and services in a nation's gross domestic product over time.
    • Again, if the current rate is 1% and it is -2% for the following month, prices disinflated by 3% (i.e., 1%-[-2]%) and are decreasing at a 2% annual rate.
    • The causes of disinflation are either a decrease in the growth rate of the money supply, or a business cycle contraction (recession).
    • When the growth rate of unemployment is below the natural rate of growth, this leads to an increase in the rate of inflation; whereas, when the growth rate of unemployment is above the natural rate of growth it leads to a decrease in the rate of inflation also known as disinflation.