Schweser says regarding SGR: “If the actual growth rate is forecasted to be greater than SGR, the firm will have to issue equity unless the firm increases its retention ratio, profit margin, total asset turnover, or leverage.” I can’t quite makes sense of this. The relevant equation is: g (or SGR) = retention ratio x profit margin x TA turnover x leverage or g = (NI-divs)/NI x NI/sales x sales/TA x TA/SE If I understand correctly, they are saying that if SGR is lower than the growth rate implied by valuation, etc, to increase SGR, either retention ratio, profit margin, TA turnover or leverage need to increase. I get that. How does issuing equity help?
well, the equation you listed is g=RR*ROE. So (and this is just a guess) if you issue additional equity, it would bring the ROE down and thus adjust the growth rate down.
right… but I believe we want the growth rate (SGR in this interpretation) to increase. I think the problem in the sentence is that the term “actual forecasted growth rate” is not explained. Perhaps they mean forecasted based on the valuation using the Gordon growth model? V0 = D1/(r-g) where all else is given except the expected growth. if the valuation is higher than it should be based on the divs paid and the req’d rate of return, then g would be high. So needing to raise SGR by raising ROE components makes sense… how does issuing equity make sense…
The SGR (sustainable growth rate) is the rate of growth that can be FINANCED under the current capital structure, operations, and profit margins. The forecasted growth rate here is probably the growth rate that is implied by the current market price. If that forecasted rate of growth is greater than what can be sustained under current operating and capital conditions, it can only be sustained by: 1. Increasing the SGR through greater efficiency and profitability (Increase Dupont ROE) 2. Increase the Earnings Retention Ratio (fund the growth internally) 3. Raise additional capital from the outside. This is the last option if the growth can not be funded internally. 4. Nothing happens and the market adjusts and prices in the lower SGR by dropping the stock price.
ha ha… it will dilute the valuation per share. i think that might be what they’re getting at. Thanks
I agree on those 4 options to increase the growth rate. But which of those 4 options matches what the text suggests? namely “issue equity” as a way for SGR to get closer to the expected (higher) growth rate… “Raising equity” would actually make SGR get farther away (lower) from the 'expected growth rate" , no?
I’m still confused…