Sustainable Growth Rates (SGR) From A Financial Perspective
The sustainable growth rate according to Robert C. Higgins is the maximum growth rate a company can achieve consistent with the firm`s established financial policy. Basically, it is calculated as:
SGR = (pm*(1-d)*(1+L)) / (T-(pm*(1-d)*(1+L)))
- pm is the existing and target profit margin
- d is the target dividend payout ratio
- L is the target total debt to equity ratio
- T is the ratio of total assets to sales
In order to grow faster, the company would have to invest more equity capital, increase its financial leverage or increase the target profit margin.
The sustainable growth rate model assumes several simplifications such as depreciation is sufficient to maintain the value of existing assets, the profit margin remains stable (also for new businesses), the proportion of assets and sales remains stable (also for new businesses) and the company maintains its current capital structure and dividend payout policy. The sustainable growth rate model has implications for valuation models, as for instance the Gordon model and other discounted cash flow models require a growth estimate that can be sustained for many years. The sustainable growth rate can be a check if business plans are reasonable.
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