Expected Growth Rate Calculator: Forecast Future Performance
The expected growth rate represents the anticipated rate at which a company's earnings, dividends, revenue, or other financial metrics will increase over time. This critical financial metric enables investors to value stocks using dividend discount models, assess whether companies can sustain current valuations, project future earnings for investment decisions, and compare growth expectations across different securities. Understanding how to calculate expected growth rates using multiple methods—including sustainable growth rate formulas, historical trend analysis, and analyst consensus projections—empowers investors to make informed decisions about growth stock valuations and income investment sustainability.
Expected Growth Rate Calculators
Sustainable Growth Rate Calculator
Based on ROE and earnings retention
Historical Growth Rate Calculator
Retention Growth Model
Calculate expected growth from reinvestment
PEG Ratio & Growth Analysis
Understanding Expected Growth Rate
Expected growth rate quantifies the anticipated percentage increase in a company's financial metrics—typically earnings, dividends, or revenue—over future periods. This forward-looking metric differs from historical growth rates, which measure past performance. Investors use expected growth rates to value stocks through dividend discount models, assess whether current stock prices reflect reasonable growth assumptions, and compare investment opportunities across different growth profiles. A company trading at high multiples requires high expected growth to justify its valuation, while mature companies with low expected growth typically trade at lower price-to-earnings ratios.
Multiple methods estimate expected growth rates, each with distinct advantages and limitations. The sustainable growth rate formula calculates internally-funded growth based on profitability and dividend policy. Historical growth analysis projects future trends from past performance. Analyst consensus aggregates professional forecasts. Understanding these methodologies and their appropriate applications enables investors to develop informed growth expectations rather than accepting analyst projections uncritically or extrapolating historical trends mechanically.
Sustainable Growth Rate Formula
The sustainable growth rate represents the maximum rate at which a company can grow using internally generated funds without raising external capital or changing its capital structure. This metric reveals how much a company can grow through retained earnings alone.
\[ g = ROE \times b \]
Where:
\( g \) = Sustainable growth rate
\( ROE \) = Return on Equity
\( b \) = Retention ratio (proportion of earnings retained)
Alternative Formulation:
\[ g = ROE \times (1 - \text{Payout Ratio}) \]
Component Calculations:
\[ ROE = \frac{\text{Net Income}}{\text{Shareholders' Equity}} \]
\[ b = \frac{\text{Retained Earnings}}{\text{Net Income}} = 1 - \frac{\text{Dividends}}{\text{Net Income}} \]
Sustainable Growth Rate Example
Company Financial Data:
- Return on Equity (ROE): 15%
- Dividend Payout Ratio: 40%
- Retention Ratio: 60% (1 - 0.40)
Calculate Sustainable Growth Rate:
\[ g = ROE \times b \] \[ g = 0.15 \times 0.60 = 0.09 = 9\% \]Results:
- Sustainable Growth Rate: 9% per year
- Earnings Retained: 60%
- Return on Reinvested Capital: 15%
Interpretation: With a 15% ROE and 60% retention ratio, the company can sustain 9% annual earnings growth without external financing. The company retains 60% of earnings and reinvests them at 15% returns, generating 9% growth. To grow faster than 9% sustainably, the company must either improve ROE or retain more earnings (reduce dividends).
Verification:
If the company earns $1 million and retains $600,000 (60%), reinvesting at 15% ROE produces $90,000 in additional earnings next year. This represents 9% growth on the original $1 million.
Return on Equity (ROE) Component
ROE measures how efficiently a company generates profits from shareholders' equity. Higher ROE enables higher sustainable growth for any given retention ratio.
\[ ROE = \frac{\text{Net Income}}{\text{Shareholders' Equity}} \times 100\% \]
DuPont Analysis (ROE Decomposition):
\[ ROE = \text{Profit Margin} \times \text{Asset Turnover} \times \text{Equity Multiplier} \]
\[ ROE = \frac{\text{Net Income}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}} \]
DuPont analysis reveals whether high ROE comes from operational efficiency (profit margin), asset productivity (turnover), or financial leverage (equity multiplier). Sustainable high ROE typically derives from profit margins and turnover rather than excessive leverage.
Retention Ratio and Dividend Policy
The retention ratio determines what proportion of earnings management reinvests in the business versus distributes as dividends. This policy choice directly impacts sustainable growth capacity.
\[ b = 1 - \text{Payout Ratio} = \frac{\text{Retained Earnings}}{\text{Net Income}} \]
Relationship:
\[ \text{Retention Ratio} + \text{Payout Ratio} = 1 \text{ (or 100%)} \]
Retention Ratio Example
Company Earnings:
- Net Income: $10,000,000
- Dividends Paid: $4,000,000
- Retained Earnings: $6,000,000
Calculate Retention Ratio:
\[ b = \frac{\$6{,}000{,}000}{\$10{,}000{,}000} = 0.60 = 60\% \]Calculate Payout Ratio:
\[ \text{Payout} = \frac{\$4{,}000{,}000}{\$10{,}000{,}000} = 0.40 = 40\% \]Verification:
\[ 60\% + 40\% = 100\% \]Analysis: The company retains 60% of earnings for reinvestment and pays out 40% as dividends. Higher retention enables faster growth but provides less current income to shareholders. The optimal balance depends on investment opportunities' quality and shareholder preferences.
Comprehensive Sustainable Growth Example
Complete Calculation from Financial Statements
Company Financial Data:
- Net Income: $10,000,000
- Shareholders' Equity: $50,000,000
- Total Dividends: $4,000,000
- Retained Earnings: $6,000,000
Step 1: Calculate ROE
\[ ROE = \frac{\$10{,}000{,}000}{\$50{,}000{,}000} = 0.20 = 20\% \]Step 2: Calculate Retention Ratio
\[ b = \frac{\$6{,}000{,}000}{\$10{,}000{,}000} = 0.60 = 60\% \]Step 3: Calculate Sustainable Growth Rate
\[ g = ROE \times b = 0.20 \times 0.60 = 0.12 = 12\% \]Results:
- Sustainable Growth Rate: 12%
- ROE: 20%
- Retention Ratio: 60%
- Payout Ratio: 40%
Five-Year Projection:
Starting earnings: $10,000,000
- Year 1: $10,000,000 × 1.12 = $11,200,000
- Year 2: $11,200,000 × 1.12 = $12,544,000
- Year 3: $12,544,000 × 1.12 = $14,049,280
- Year 4: $14,049,280 × 1.12 = $15,735,194
- Year 5: $15,735,194 × 1.12 = $17,623,417
Analysis: At 12% sustainable growth, earnings grow from $10 million to approximately $17.6 million over five years if the company maintains its 20% ROE and 60% retention ratio. This internal growth requires no external capital raising.
Historical Growth Rate Method
Historical growth analysis calculates past compound annual growth rates to project future trends, assuming historical patterns continue.
\[ g = \left(\frac{V_{\text{end}}}{V_{\text{start}}}\right)^{\frac{1}{n}} - 1 \]
Where:
\( V_{\text{end}} \) = Ending value
\( V_{\text{start}} \) = Starting value
\( n \) = Number of years
In percentage form:
\[ g = \left[\left(\frac{V_{\text{end}}}{V_{\text{start}}}\right)^{\frac{1}{n}} - 1\right] \times 100\% \]
Historical Growth Example
Earnings History:
- EPS Five Years Ago: $2.00
- Current EPS: $3.50
- Time Period: 5 years
Calculate Historical Growth Rate:
\[ g = \left(\frac{\$3.50}{\$2.00}\right)^{\frac{1}{5}} - 1 \] \[ g = (1.75)^{0.2} - 1 = 1.1184 - 1 = 0.1184 = 11.84\% \]Results:
- Historical Growth Rate: 11.84% per year
- Total Growth: 75% over 5 years
- EPS increased: $1.50 ($3.50 - $2.00)
Using as Expected Growth:
If we assume the 11.84% growth continues, project EPS for next 5 years:
- Year 1: $3.50 × 1.1184 = $3.91
- Year 2: $3.91 × 1.1184 = $4.37
- Year 3: $4.37 × 1.1184 = $4.89
- Year 4: $4.89 × 1.1184 = $5.47
- Year 5: $5.47 × 1.1184 = $6.12
Caution: Historical growth doesn't guarantee future performance. Companies mature, competition intensifies, and growth rates typically moderate over time. Use historical rates cautiously and adjust for changed circumstances.
Growth Rate Methods Comparison
| Method | Formula | Best Use | Limitations |
|---|---|---|---|
| Sustainable Growth | ROE × Retention Ratio | Internal growth capacity | Assumes constant ROE |
| Historical CAGR | (End/Start)^(1/n) - 1 | Trend extrapolation | Past ≠ future |
| Analyst Consensus | Average of forecasts | Forward-looking | Often optimistic |
| Dividend Growth | Historical dividend CAGR | Income investing | Ignores business growth |
PEG Ratio and Growth Valuation
The PEG ratio relates a stock's P/E ratio to its expected growth rate, helping assess whether a stock's valuation is reasonable given growth expectations.
\[ \text{PEG} = \frac{\text{P/E Ratio}}{\text{Expected Growth Rate}} \]
Where growth rate is expressed as a whole number (e.g., 15, not 0.15)
P/E Ratio:
\[ \text{P/E} = \frac{\text{Stock Price}}{\text{Earnings per Share}} \]
Interpretation:
PEG < 1.0: Potentially undervalued relative to growth
PEG = 1.0: Fair value
PEG > 2.0: Potentially overvalued relative to growth
PEG Ratio Example
Stock A:
- Stock Price: $100
- EPS: $5.00
- Expected Growth: 20% per year
Calculate P/E Ratio:
\[ \text{P/E} = \frac{\$100}{\$5} = 20 \]Calculate PEG Ratio:
\[ \text{PEG} = \frac{20}{20} = 1.0 \]Stock B:
- Stock Price: $50
- EPS: $2.50
- Expected Growth: 10% per year
Calculate P/E and PEG:
\[ \text{P/E} = \frac{\$50}{\$2.50} = 20 \] \[ \text{PEG} = \frac{20}{10} = 2.0 \]Comparison:
- Stock A: P/E of 20, PEG of 1.0
- Stock B: P/E of 20, PEG of 2.0
Analysis: Both stocks have identical P/E ratios of 20, but Stock A appears more attractive with a PEG of 1.0 versus Stock B's 2.0. Stock A's 20 P/E seems reasonable for 20% growth, while Stock B's 20 P/E appears expensive for only 10% growth. Stock A offers better growth per dollar of valuation.
Factors Affecting Growth Rates
Company Life Cycle
Young companies typically exhibit high growth rates that moderate as they mature. Established companies face market saturation and size constraints that limit percentage growth. Investors should adjust growth expectations based on company stage.
Market Size and Competition
Total addressable market limits potential growth. Companies in large, growing markets can sustain high growth longer than those in mature, saturated markets. Competitive intensity affects both profitability (ROE) and market share expansion.
Capital Intensity
Capital-intensive businesses require significant reinvestment to grow, limiting sustainable growth for any given profitability level. Asset-light businesses can achieve higher growth with less retained earnings.
Economic Conditions
Macroeconomic growth rates constrain company growth over long periods. No company can sustainably grow much faster than the overall economy indefinitely without eventually dominating it.
Adjusting Growth Expectations
Mean Reversion: Extremely high or low growth rates tend to revert toward industry and economy-wide averages over time. Adjust long-term projections toward sustainable levels.
Competitive Advantages: Companies with strong moats can sustain above-average growth longer. Assess whether competitive advantages support projected growth rates.
Management Quality: Track record of capital allocation and strategic execution impacts whether companies achieve expected growth. Consider management's history when setting expectations.
Industry Trends: Secular growth or decline trends in industries affect individual company prospects. Align expectations with industry dynamics.
Common Mistakes
- Extrapolating Recent Growth: Assuming recent high growth continues indefinitely without considering maturation
- Ignoring ROE Sustainability: Projecting high growth without verifying the company can maintain high returns on equity
- Overlooking Capital Needs: Failing to account for capital intensity that limits internally-funded growth
- Accepting Analyst Consensus Uncritically: Analyst projections are often optimistic; verify assumptions independently
- Using Wrong Time Periods: Calculating historical growth from peak or trough years distorts reality
- Confusing Growth Types: Mixing revenue growth with earnings growth, which often differ significantly
- Neglecting Valuation: Chasing high-growth companies without ensuring reasonable valuations
Practical Applications
Stock Valuation
Expected growth rates drive dividend discount models and justify P/E ratios. Higher sustainable growth supports higher valuations, while low growth companies should trade at discounts.
Investment Screening
Filter stocks by growth characteristics matching your investment strategy. Growth investors seek high expected growth; value investors prefer reasonable growth at low prices.
Portfolio Construction
Balance high-growth, high-risk investments with slower-growing, stable companies to optimize risk-adjusted returns aligned with goals and time horizon.
Dividend Sustainability
Compare dividend growth rates to sustainable growth rates. Dividend growth exceeding sustainable growth signals potential future cuts or payout ratio compression.