The sustainable growth rate is the rate of growth that a company can expect to see in the long term. It can be calculated by multiplying a company’s earnings retention rate by its return on equity. 

The sustainable growth rate is an indicator of what stage a company is in during its life cycle. The position often determines corporate finance objectives, such as financing sources, dividend payout policies, and overall competitive strategy.

Creditors can also use the growth ratio to determine the likelihood of a company defaulting on its loans. A high growth rate may indicate that the company is focusing on investing in R&D and NPV-positive projects, which may delay debt repayment. A high-growth-rate company is generally considered riskier, as it likely sees greater earnings volatility from period to period.

How to Calculate the Sustainable Growth Rate?

The sustainable growth rate is calculated as the trailing twelve-month Retention Rate multiplied by the trailing twelve-month Return on Equity, divided by 100

Sustainable Growth Rate = Retention Rate * Return on Equity / 100

Where:

Retention Rate – [ (Net Income – Dividends) / Net Income) ]. This represents the percentage of earnings the company has not paid out in dividends. In other words, how much profit the company retains, where Net Income – Dividends is equal to Retained Earnings.

Return on Equity – (Net Income / Total Shareholder’s Equity). This represents how much return investors have realized relative to the company's profit.

A very high growth rate signifies that a company is still growing quickly. As such, the company may be spending a lot of its earnings on research and development and may not have a lot of cash left over to make debt payments. Therefore, a growing company could benefit more from equity financing and issuing stock to finance its operations.