Growth Unlocked: Mastering CAGR and Sustainable Growth Rate
In the fast-paced world of business and finance, understanding how a company grows over time is critical for investors, managers, and stakeholders alike. Two key metrics that help decode growth are CAGR (Compound Annual Growth Rate) and the Sustainable Growth Rate (SGR). While both measure growth, they serve different purposes and provide unique insights into a company’s performance and financial health.
Is your growth strategy backed by numbers or just intuition?
Understanding growth is more than numbers—it’s strategy in action. Track past success with CAGR and plan ahead with Sustainable Growth Rate. Make every decision count!
What is CAGR?
The Compound Annual Growth Rate (CAGR) measures the mean annual growth rate of an investment or business metric over a specified period of time, assuming profits are reinvested at the end of each year. Unlike simple growth rates, CAGR accounts for the effects of compounding, giving a smoothed annual growth rate that eliminates the volatility of year-to-year fluctuations.
Formula:
- CAGR = [(Ending Value / Beginning Value) ^ (1 / Number of Years)] - 1
Example: If a company’s revenue grew from ₹50 lakh to ₹100 lakh over 5 years, CAGR would be:
- CAGR = [(100 / 50) ^ (1/5)] - 1 = 14.87%
This indicates that the company’s revenue grew at an average rate of ~14.87% per year over the 5-year period.
What is Sustainable Growth Rate (SGR)?
The Sustainable Growth Rate (SGR) measures the rate at which a company can grow its sales, earnings, and dividends without changing its capital structure or needing external financing. It reflects the maximum growth a business can achieve using internally generated funds while maintaining a stable debt-to-equity ratio.
Formula:
- SGR = Return on Equity (ROE) × (1 – Dividend Payout Ratio)
Example: A company with an ROE of 15% and a dividend payout ratio of 40% would have:
- SGR = 15% × (1 – 0.40) = 9%
This means the company can sustainably grow its equity by 9% per year without seeking external financing.
CAGR vs. Sustainable Growth Rate: Key Differences
- Scope: CAGR tracks actual historical growth, while SGR indicates potential future growth based on financial policies.
- Purpose: CAGR helps evaluate performance over time; SGR helps in planning and setting realistic growth targets.
- Dependency: CAGR depends on revenue or investment figures; SGR depends on ROE and dividend policies.
Why Understanding Growth Ratios Matters
- Strategic Planning: Companies can set realistic growth targets based on SGR and track performance using CAGR.
- Investor Insights: CAGR helps investors understand historical performance, while SGR signals future growth sustainability.
- Financial Health: Monitoring SGR ensures businesses don’t overextend and maintain healthy equity and debt levels.
Conclusion
Mastering growth ratios like CAGR and Sustainable Growth Rate is essential for unlocking the full potential of a business. While CAGR tells the story of past performance, SGR provides a roadmap for sustainable, long-term growth. By understanding and applying both, businesses and investors can make smarter decisions, ensuring growth is both profitable and sustainable.
