 # Growth (g)

I fully understand the sustainable growth rate = ROE*Retention ratio, BUT… I am not fully understanding what g represents. For example, there may be a mature company with an ROE at 7%(and they plow back all of their earnings), but NI, OCF, FCF, FCFF, FCFE, etc. have only been growing at 3%. Why would you use the 7% as your estimate for what your CF’s will grow at (in your DCF), when they are literally growing a at a much slower pace? What is the theoretical backing for this madness? I thought I totally understood this stuff, but sometimes I lose my head! Help!

Shareholders enjoy two sources of return from holding a stock: dividends, and price appreciation. If retention ratio is 100%, there are no dividends, but the price appreciates greatly. If retention ratio is 0%, there are huge dividends and the price doesn’t change. So given the same ROE you can see the firm grow between 0% (or even less I suppose) and that ROE.

let me see if I can get this straight. I can possibly understand this when using g in the gordon growth model equation (with growth at a constant rate). But I don’t see why I would use this for the growth in cash flows for a multi stage DCF, because the CF’s may not actually be growing as fast as ROE with full retention. I think this is the source of my confusion: The growth rate is supposed to be the rate that the Cash flows grow, right? Or is it supposed to be the growth rate of equity? OR can you have 2 growth rates (1 for Cash flows and 1 for equity)? Below is an example with my exact dilemma: i.e. My EQUITY will grow by my ROE (assuming full retention), but my NI will grow less than this. Year 1: ROE - 10% Equity - 100 NI = 10 Year 2: Equity = 110 NI = 10.5 ROE = 9.5% growth in NI: 5% In this method, cash flow growth is not the same as ROE, thus ROE would be an innapropriate g for future cash flow growth, right? Should you use a lower growth rate for your cash flows until reaching and end g? my growth in NI was only 5%, while my ROE was 9.5%. Which g should I use for my cash flows?

can someone please explain this to me, because I cannot find the answer in the curriculum.