Sustainable Growth Rate
Maximum growth rate a company can sustain without external financing: ROE multiplied by the retention ratio (1 − payout). Connects dividend policy and capital efficiency to the growth rate input every other valuation formula needs.
When to use: Use to estimate a defensible growth-rate input for DDM and DCF models. SGR is the growth a business funds entirely from retained earnings — over the long run, actual growth cannot exceed SGR without raising new capital or improving ROE.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| SGR | Sustainable Growth Rate | Internally-fundable growth rate, as a decimal | % |
| ROE | Return on Equity | Net income ÷ shareholders' equity, as a decimal | % |
| Payout | Payout Ratio | Dividends ÷ earnings, as a decimal | % |
Real-Life Examples
Example 1: High-ROE Company, 30% Payout
Company has 20% ROE and pays out 30% of earnings as dividends.
Given
Step-by-Step
Sustainable growth is 14% — the company can grow earnings 14% per year using only retained profits. Faster growth requires either higher ROE, lower payout, or new external capital (debt or equity).
Frequently Asked Questions
A company's book equity grows by retained earnings: ΔEquity = NetIncome × (1 − Payout). Returns on that equity grow at ROE, so earnings growth ≈ ROE × retention. The math captures the self-funding limit.
The company is leveraging up (issuing debt) or diluting (issuing equity) to fund the gap. Either is fine for a period, but unsustainable indefinitely — eventually the leverage runs out or the dilution destroys per-share value.
The Gordon model assumes perpetual constant growth. SGR is the realistic upper bound for that g. Plug SGR into Gordon (rather than guessing a higher growth rate) and the result is a defensible intrinsic-value estimate anchored to the company's actual capital efficiency.