Sustainable Growth Rate: Formula, Example & Limitations

The sustainable growth rate (SGR) is the maximum rate at which a company can grow its sales, earnings, and dividends without issuing new equity or changing its debt-to-equity ratio. It is calculated as ROE × (1 − Dividend Payout Ratio).”

TL;DR – Sustainable Growth Rate (SGR)

• Definition: The maximum rate at which a company can grow earnings/dividends without new equity or more debt.
• Formula: SGR = ROE × (1 − Dividend Payout Ratio)
• Why it matters: Investors use SGR to test if growth forecasts are realistic.
• Tool: Use our free Excel SGR calculator to run your own scenarios.

What Is the Sustainable Growth Rate?

The sustainable growth rate (SGR) is the maximum pace at which a company can expand sales, earnings, and dividends using only retained earnings, while keeping its debt-to-equity ratio constant.

In simple terms:

• If a firm grows faster than SGR, it must raise external financing.
• If it grows more slowly, it builds excess cash.

This makes SGR a reality check for both corporate planners and investors.
(Source: Investopedia)

Sustainable Growth Rate Formula

The widely used formula is:

SGR=ROE×(1−Dividend Payout Ratio)

Where:

• ROE = Net Income ÷ Average Shareholders’ Equity
• Dividend Payout Ratio = Dividends ÷ Net Income
• Retention Ratio = 1 − Payout Ratio

So, put simply:
SGR = ROE × Retention Ratio

Step-by-Step: How to Calculate SGR

Here’s a simple walk-through:

1. Find ROE
   • Example: Net income = $50M; Avg equity = $500M
   • ROE = 50 ÷ 500 = 10%
2. Find Dividend Payout Ratio
   • Example: Dividends = $10M; Net income = $50M
   • Payout = 10 ÷ 50 = 20%
3. Calculate Retention Ratio
   • 1 − 0.20 = 80%
4. Multiply ROE × Retention Ratio
   • 10% × 80% = 8%

This company can grow earnings at 8% per year without new capital.

Worked Example With Sensitivity Table

Let’s use Company A:

• Net Income: $100M
• Equity: $500M → ROE = 20%
• Dividends: $30M → Payout = 30%
• Retention = 70%

SGR = 20% × 70% = 14%

Now test payout scenarios:

Why Sustainable Growth Rate Matters

Investopedia emphasizes the basics, but here’s how to go deeper:

1. For management, SGR sets the ceiling on growth without external financing.
2. For investors — If analyst forecasts exceed SGR, it’s a red flag.
3. For valuation models, SGR is often the long-term growth input in the Gordon Growth Model (Dividend Discount Model).
4. For capital planning — Helps decide dividend policy vs. reinvestment.

Limitations of SGR

While Investopedia touches on this, let’s expand:

• Assumes constant leverage (debt/equity doesn’t change in reality).
• Buybacks distort equity (boost ROE → inflate SGR).
• Ignores new equity issuance (which many growth firms rely on).
• Cyclical earnings can give misleading ROE snapshots.
• Industry variations mean benchmarks matter more than single numbers.

Industry Benchmarks: Typical SGR by Sector

One way to outperform Investopedia is by providing contextual data:

SGR vs Internal Growth Rate (IGR)

• Internal Growth Rate (IGR): assumes no debt financing (purely retained earnings).
• Sustainable Growth Rate (SGR): assumes constant leverage.
  SGR is usually higher than IGR because leverage can boost ROE.

How Investors Use SGR in Valuation

SGR is especially useful in the Dividend Discount Model (DDM):

Value = D1 / r−g

Where g = sustainable growth rate.

Example:

• Dividend = $2/share
• Required return = 10%
• SGR = 6%

V= 2 / 0.10−0.06 = $50V

If analysts project 10% growth but SGR is 6%, the higher number is likely unsustainable.

Final Thoughts

The sustainable growth rate is a compact but powerful metric for investors and management. Use it as a sanity check against ambitious growth forecasts and always compare across industries.