What this calculator does
A company can only grow so fast on its own money. The sustainable growth rate is the ceiling: how much it can expand using retained earnings without raising new equity or increasing leverage.
It links dividend policy directly to growth. A business earning a 30.0 per cent return on equity and retaining everything can grow at 30.0 per cent, but paying out two thirds of profit drops that ceiling to 10.0 per cent. Every dollar distributed is a dollar not funding expansion.
The formula
Multiply the retention ratio, being the share of profit kept rather than paid out, by the return on equity. The product is the rate at which equity, and therefore the business, can grow unaided.
| Term | Meaning |
|---|---|
| Retention ratio | The proportion of net income retained rather than distributed. |
| Return on equity | Net income divided by shareholders' equity. |
| Sustainable growth rate | Retention times return on equity, the self-funded growth ceiling. |
The inputs explained
| Field | What to enter |
|---|---|
| Net income ($) | Net income for the year. |
| Dividends paid ($) | Total dividends paid out of that income. |
| Shareholders’ equity ($) | Shareholders' equity at the start of the period. |
When to use it
Testing a growth plan
A plan to grow faster than this rate requires new funding, and it is better to know that in advance.
Setting dividend policy
Seeing the growth given up by each dollar distributed makes the trade-off explicit.
Assessing a forecast
A projection well above the sustainable rate, with no funding plan attached, deserves scrutiny.
Worked examples
Every figure in the tables below is produced by this page’s own calculator at build time, so the numbers and the tool always agree. Select any row to load that scenario.
How much growth does each dividend level cost?
The same earnings with three dividend policies.
Questions
What if growth needs to exceed this rate?
Then it has to be funded, either by issuing new shares, by borrowing more, or by improving the underlying return on equity. None of these is wrong, but all three are decisions rather than things that happen by themselves.
Why does paying dividends limit growth?
Because distributed profit leaves the business and cannot fund new assets. The trade-off is direct: every dollar paid out is a dollar unavailable for expansion.
Is growing at the maximum rate desirable?
Not necessarily. Growth only creates value when the returns justify it, and a business with limited good opportunities often serves shareholders better by returning cash than by expanding into weaker projects.
How does this relate to the dividend discount model?
The sustainable growth rate is the standard way to estimate the growth term in that model. Using it keeps the valuation internally consistent rather than assuming a growth rate the business cannot actually fund.
For the dividend side of the trade-off, see the dividend yield and payout calculator. For what drives the return on equity, see the DuPont analysis calculator.