What is the sustainable growth rate and how does it differ from a firm's actual growth?

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AcadiFi · Accepted Answer

Sustainable Growth Rate (SGR) is the maximum rate at which a firm can grow without external financing (new equity or incremental debt beyond maintaining current leverage): SGR = ROE × b, where b is the retention ratio (1 − payout). It answers: 'at current profitability and reinvestment, how fast can the firm grow organically?'

For Marbellion: if ROE = 16% and payout = 50%, SGR = 16% × 0.5 = 8%. Actual growth of 14% means the firm is growing faster than sustainable — financing the gap via external capital (new debt, new equity, or increasing leverage).

Reconciliation possibilities: (1) the firm raised debt — check the cash flow statement for financing inflows; (2) working capital turned more efficient, releasing cash; (3) asset turnover improved, lifting ROE above the SGR inputs; (4) payout ratio dropped without being reflected in the stale assumption; (5) M&A added revenue not organically generated.

The PRAT framework decomposes SGR further: SGR = P × R × A × T, where P = profit margin, R = retention ratio, A = asset turnover, T = equity multiplier (assets/equity). This ties sustainable growth to operational and financial levers, showing what management would need to change to support actual growth organically.

Analyst reads: persistent SGR < actual growth is a flag — either (a) the firm is increasing leverage or diluting equity (quality concern), or (b) the firm is in hypergrowth and will converge to SGR once it matures. Compare SGR to long-run observed growth — when actual consistently exceeds SGR by wide margins, question whether current ROE is sustainable.

What is the sustainable growth rate and how does it differ from a firm's actual growth?

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