Sustainable Growth Rate (SGR)

Sustainable Growth Rate (SGR)

What it is

The Sustainable Growth Rate (SGR) is the maximum rate at which a company can grow sales, earnings, and assets using only internally generated funds—without issuing new equity or taking on additional debt. It reflects how quickly a firm can expand while maintaining its existing capital structure and dividend policy.

Formula and how to calculate it

SGR can be expressed two equivalent ways:

• SGR = Retention Ratio × Return on Equity (ROE)
• SGR = ROE × (1 − Dividend Payout Ratio)

Where:
– ROE = Net income ÷ Shareholders’ equity
– Dividend Payout Ratio = Dividends ÷ Net income
– Retention Ratio = 1 − Dividend Payout Ratio (the portion of earnings retained for reinvestment)

Example: If ROE = 15% and dividend payout = 40%, then retention = 60% and
SGR = 0.60 × 0.15 = 0.09 → 9% sustainable growth per year.

What SGR tells you

• The SGR indicates how fast a company can grow without external financing.
• It helps assess whether current operations, margins, and working capital management are sufficient to support planned expansion.
• Lenders and investors may use SGR to judge whether growth plans require external capital and whether a firm can service additional debt.

Operational drivers that affect SGR

SGR depends on the company’s profitability and how much profit is retained. Key operational levers include:
– Increasing ROE (improve profit margins, asset efficiency, or capital structure)
– Raising the retention ratio (reduce dividend payouts)
– Improving working capital management (faster collections, better inventory control, longer payable terms)

Actions to increase growth beyond SGR typically involve trade-offs: issuing equity, taking on more debt, cutting dividends, introducing higher-margin products, or improving operational efficiency.

Limitations and assumptions

SGR is a useful planning metric but rests on simplifying assumptions:
– Assumes a constant target capital structure (debt/equity mix) and a fixed dividend payout.
– Assumes ROE and profit margins remain stable as the firm grows.
– Ignores external factors like changing consumer demand, competition, or economic cycles.
– Underestimates capital needs for industries that require heavy investment in fixed assets (PP&E).
– Should be compared with industry peers for meaningful benchmarking.

Practical consequences: sustaining a high SGR over the long term can be difficult—market saturation, lower-margin product expansion, and increased capital expenditures may push a firm to seek external financing.

SGR vs. PEG ratio

• SGR measures the internally financeable growth rate based on profitability and retention.
• The PEG ratio (P/E divided by earnings growth) is a market valuation metric comparing share price to expected earnings growth.
  They serve different purposes: SGR is an operational/financial planning tool; PEG is used to assess valuation relative to growth expectations.

How companies use SGR

• Long-term growth planning and setting realistic expansion targets
• Cash flow and capital expenditure forecasting
• Deciding whether external financing is necessary (debt or equity)
• Informing dividend policy and reinvestment strategy

Key takeaways

• SGR is the growth a firm can support using only its retained earnings given current ROE and payout policy.
• It is calculated as ROE × (1 − Dividend Payout Ratio) or Retention Ratio × ROE.
• Operational improvements can raise SGR, but long-term sustainability often requires trade-offs or external capital.
• Use SGR alongside industry benchmarks and other financial metrics when planning growth or evaluating financing needs.