Sustainable growth rate

The sustainable growth rate is the maximum rate at which a company can grow its revenue and earnings using only the profit it generates internally, without having to raise additional capital by taking on new debt or issuing new shares. It combines how profitable the company is with how much of that profit it reinvests rather than pays out as dividends.

The formula is:

The retention ratio is the share of net income the company keeps and reinvests in the business rather than distributing to shareholders as dividends, so a company that pays out a smaller share of its earnings as dividends retains more capital to fund growth, all else equal. A company with a high return on equity and a high retention ratio can sustain fast growth purely from its own profits. A company with a lower return on equity, or one that pays out most of its earnings as dividends, has a much lower ceiling on how fast it can grow without turning to outside financing.

The sustainable growth rate is a useful sanity check when a company is reporting or guiding to growth well above what this formula would suggest it can fund internally. That gap doesn't necessarily mean anything is wrong, the company may simply be raising debt or equity deliberately to fund expansion faster than its own profits allow, but it does mean that growth is being financed rather than self-funded, which changes how durable it is if external financing becomes harder or more expensive to obtain.