Sustainable Growth Rate Calculator
Calculate the Sustainable Growth Rate (SGR) – the maximum rate at which a company can grow its revenue and net income without needing to issue new equity or take on new debt, assuming a constant debt-to-equity ratio.
Enter the company's **Net Income**, **Shareholder Equity**, and **Dividends Paid** to determine the Sustainable Growth Rate. Ensure all values are for the same fiscal period.
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Understanding Sustainable Growth Rate (SGR)
What is Sustainable Growth Rate?
The Sustainable Growth Rate (SGR) is a financial metric used to estimate the maximum rate at which a company can increase its revenue and net income without resorting to external equity financing or increasing its financial leverage (debt-to-equity ratio).
It assumes the company wants to maintain its current operating efficiency, financial leverage, and dividend payout policy. The SGR essentially tells you how fast a company can grow by reinvesting its own profits.
SGR Formula
The most common formula for SGR is:
SGR = Return on Equity (ROE) * Retention Rate
Where:
- Return on Equity (ROE) = Net Income / Shareholder Equity
- Retention Rate = (Net Income - Dividends Paid) / Net Income
This can also be expressed directly using Net Income, Shareholder Equity, and Dividends Paid:
SGR = ((Net Income - Dividends Paid) / Net Income) * (Net Income / Shareholder Equity)
Which simplifies (when Net Income ≠ 0) to:
SGR = (Net Income - Dividends Paid) / Shareholder Equity
Our calculator uses the conceptual ROE * Retention Rate approach by first calculating ROE and Retention Rate, then multiplying them.
Key Components Explained
- Net Income: The profit remaining after all expenses, interest, and taxes.
- Shareholder Equity: The value of the owners' stake in the company (Assets - Liabilities). Represents the capital base the company operates with.
- Dividends Paid: The portion of Net Income distributed to shareholders.
- Retained Earnings: Net Income minus Dividends Paid. This is the profit kept by the company for reinvestment.
- Retention Rate: The percentage of Net Income that is retained (not paid out as dividends). A higher retention rate means more capital is available for internal reinvestment and growth.
- Return on Equity (ROE): Measures how effectively a company uses shareholder equity to generate profit. A higher ROE indicates better profitability from the owners' perspective.
Why is it "Sustainable"?
Growth powered solely by reinvesting profits and maintaining the existing debt-to-equity structure is considered sustainable because it doesn't require external capital injections (beyond debt proportional to equity growth) that might dilute ownership or increase financial risk disproportionately.
Sustainable Growth Rate Examples
Explore common scenarios to understand how SGR is calculated:
Example 1: Profitable Company, No Dividends
Scenario: A growing company generated profit and reinvested all of it.
Inputs:
- Net Income: $1,000,000
- Shareholder Equity: $5,000,000
- Dividends Paid: $0
Calculations:
- ROE = $1,000,000 / $5,000,000 = 0.20 (or 20%)
- Retention Rate = ($1,000,000 - $0) / $1,000,000 = 1.00 (or 100%)
- SGR = ROE * Retention Rate = 0.20 * 1.00 = 0.20
Result: SGR = 20%
Conclusion: This company can sustainably grow by 20% per year based on its current profitability and full reinvestment.
Example 2: Paying Dividends
Scenario: A stable company distributes a portion of its profits as dividends.
Inputs:
- Net Income: $800,000
- Shareholder Equity: $4,000,000
- Dividends Paid: $400,000
Calculations:
- ROE = $800,000 / $4,000,000 = 0.20 (or 20%)
- Retention Rate = ($800,000 - $400,000) / $800,000 = $400,000 / $800,000 = 0.50 (or 50%)
- SGR = ROE * Retention Rate = 0.20 * 0.50 = 0.10
Result: SGR = 10%
Conclusion: By paying out 50% of profits, the sustainable growth rate is reduced to 10%.
Example 3: High Retention, Lower ROE
Scenario: A company reinvests heavily but has lower profitability relative to equity.
Inputs:
- Net Income: $300,000
- Shareholder Equity: $6,000,000
- Dividends Paid: $0
Calculations:
- ROE = $300,000 / $6,000,000 = 0.05 (or 5%)
- Retention Rate = ($300,000 - $0) / $300,000 = 1.00 (or 100%)
- SGR = ROE * Retention Rate = 0.05 * 1.00 = 0.05
Result: SGR = 5%
Conclusion: Despite reinvesting all profits (100% retention), the lower ROE limits the sustainable growth to 5%.
Example 4: High ROE, High Payout Ratio
Scenario: A very profitable company pays out a large portion of its earnings as dividends.
Inputs:
- Net Income: $1,200,000
- Shareholder Equity: $4,000,000
- Dividends Paid: $900,000
Calculations:
- ROE = $1,200,000 / $4,000,000 = 0.30 (or 30%)
- Retention Rate = ($1,200,000 - $900,000) / $1,200,000 = $300,000 / $1,200,000 = 0.25 (or 25%)
- SGR = ROE * Retention Rate = 0.30 * 0.25 = 0.075
Result: SGR = 7.5%
Conclusion: High profitability (ROE) is offset by a high dividend payout, resulting in a moderate SGR.
Example 5: Zero Net Income
Scenario: A company had a breakeven year with no profit.
Inputs:
- Net Income: $0
- Shareholder Equity: $1,000,000
- Dividends Paid: $0
Calculations:
- ROE = $0 / $1,000,000 = 0 (or 0%)
- Retention Rate = ($0 - $0) / $0 (This part of the formula is undefined, but conceptually, if NI=0 and Dividends=0, Retention is 100% of zero).
- Using the simplified SGR = (NI - Dividends) / Equity: SGR = ($0 - $0) / $1,000,000 = 0 / $1,000,000 = 0
Result: SGR = 0%
Conclusion: With no profit, there are no retained earnings to fund sustainable growth. SGR is 0.
Example 6: Negative Net Income (Loss)
Scenario: A company experienced a loss during the period.
Inputs:
- Net Income: -$500,000
- Shareholder Equity: $3,000,000
- Dividends Paid: $0
Calculations:
- ROE = -$500,000 / $3,000,000 = -0.1667 (or -16.67%)
- Retention Rate = ($-500,000 - $0) / $-500,000 = 1.00 (or 100%) - A loss is 'retained' and reduces equity.
- SGR = ROE * Retention Rate = -0.1667 * 1.00 = -0.1667
Result: SGR = -16.67%
Conclusion: A loss reduces shareholder equity, resulting in a negative sustainable growth rate. The company is shrinking if it relies only on internal funds.
Example 7: Dividends Exceed Net Income
Scenario: A company paid out more in dividends than it earned in profit (e.g., from reserves or previous retained earnings).
Inputs:
- Net Income: $600,000
- Shareholder Equity: $5,000,000
- Dividends Paid: $700,000
Calculations:
- ROE = $600,000 / $5,000,000 = 0.12 (or 12%)
- Retention Rate = ($600,000 - $700,000) / $600,000 = -$100,000 / $600,000 ≈ -0.1667 (or -16.67%)
- SGR = ROE * Retention Rate = 0.12 * -0.1667 ≈ -0.02
Result: SGR ≈ -2.0%
Conclusion: Paying out more than earned results in negative retained earnings, leading to a negative sustainable growth rate. This is not sustainable long-term.
Example 8: High Equity, Moderate Profit
Scenario: A company with a large equity base but moderate profitability, retaining all earnings.
Inputs:
- Net Income: $750,000
- Shareholder Equity: $10,000,000
- Dividends Paid: $0
Calculations:
- ROE = $750,000 / $10,000,000 = 0.075 (or 7.5%)
- Retention Rate = ($750,000 - $0) / $750,000 = 1.00 (or 100%)
- SGR = ROE * Retention Rate = 0.075 * 1.00 = 0.075
Result: SGR = 7.5%
Conclusion: The large equity base results in a lower ROE, limiting the sustainable growth rate despite full reinvestment.
Example 9: Startup Phase (Often requires external funding)
Scenario: A young company focused on growth, potentially with minimal profit yet high reinvestment.
Inputs:
- Net Income: $50,000
- Shareholder Equity: $1,000,000
- Dividends Paid: $0
Calculations:
- ROE = $50,000 / $1,000,000 = 0.05 (or 5%)
- Retention Rate = ($50,000 - $0) / $50,000 = 1.00 (or 100%)
- SGR = ROE * Retention Rate = 0.05 * 1.00 = 0.05
Result: SGR = 5%
Conclusion: While this shows a 5% sustainable rate from *internal* funds, startups often aim for higher growth that requires external funding, exceeding their SGR.
Example 10: Shareholder Equity is Zero or Negative
Scenario: A company with liabilities exceeding assets, resulting in zero or negative equity.
Inputs:
- Net Income: $100,000
- Shareholder Equity: $0 (or less)
- Dividends Paid: $0
Calculations:
- ROE = $100,000 / $0 (or negative)
- Retention Rate = ($100,000 - $0) / $100,000 = 1.00 (or 100%)
- SGR = ROE * Retention Rate
Result: SGR = Undefined or Meaningless in this context.
Conclusion: When Shareholder Equity is zero or negative, the ROE is undefined or not meaningful, making the SGR formula inapplicable or indicative of significant financial distress rather than sustainable growth potential from equity.
Frequently Asked Questions about Sustainable Growth Rate
1. What is the Sustainable Growth Rate (SGR)?
The SGR is a financial metric that estimates the maximum rate at which a company can grow using only its retained earnings, without changing its debt-to-equity ratio or issuing new stock. It represents the growth rate achievable purely through internal financing and leverage maintenance.
2. What is the main formula for SGR?
The core formula is SGR = Return on Equity (ROE) * Retention Rate. ROE = Net Income / Shareholder Equity, and Retention Rate = (Net Income - Dividends Paid) / Net Income.
3. What is Return on Equity (ROE) in this context?
ROE measures how much profit a company generates for each dollar of shareholder equity. It's a key driver of SGR because it shows the profitability relative to the capital base available for reinvestment.
4. What is the Retention Rate (or Plowback Ratio)?
The Retention Rate is the percentage of net income that a company keeps (retains) after paying out dividends. It's calculated as (Net Income - Dividends Paid) / Net Income. This retained portion is reinvested in the business to fund growth.
5. How are Dividends Paid and Retention Rate related?
Dividends Paid is the amount of profit given to shareholders. The Retention Rate is inversely related to the Dividend Payout Ratio (Dividends Paid / Net Income). Retention Rate = 1 - Dividend Payout Ratio. More dividends mean less retained earnings and a lower retention rate, which reduces SGR.
6. What does it mean if SGR is high or low?
A high SGR suggests the company is profitable relative to its equity and retains a significant portion of earnings, allowing for rapid growth without external funding. A low SGR indicates limited potential for growth through internal means, perhaps due to low profitability, high dividend payouts, or a large equity base.
7. Can SGR be negative?
Yes, SGR can be negative if the company has a net loss (negative net income) or if it pays out more in dividends than it earned in net income. A negative SGR suggests the company's equity base is shrinking if it relies solely on internal financing, indicating unsustainable practices or financial distress.
8. What are the assumptions behind the SGR formula?
Key assumptions include: the company aims to maintain a constant debt-to-equity ratio, it uses only retained earnings and proportional new debt (based on the target D/E ratio) to finance growth, asset turnover and profit margin remain constant, and the dividend payout ratio remains constant.
9. Why is SGR called 'sustainable'?
It's sustainable because it represents the growth rate a company can maintain without changing its core financial structure (specifically, its leverage) or needing to dilute existing shareholders by issuing new equity. Growth above the SGR typically requires raising additional equity or increasing debt disproportionately.
10. How can a company increase its SGR?
A company can increase its SGR by: 1) Increasing its Net Income (improving profitability), 2) Using its assets more efficiently (increasing asset turnover, which impacts ROE via the DuPont analysis), 3) Increasing its financial leverage (increasing the debt-to-equity ratio, which also impacts ROE), or 4) Decreasing its dividend payout ratio (increasing the retention rate).
