“If the actual growth rate is forecasted to be greater than sustainable growth rate, the firm will have to issue equity unless the firm increases it’s retention ratio, profilt margin, total asset turnover or leverage” Nothing’s clicking after reading this, please help?
Recall g=ROE*b where g is the sustainable growth rate also recall from dupont that ROE=net prof margin*Asset turnover*Levarage well if a firm is to go above it sustainable growth rate it needs to increase either it reteention ratio(pay less div) or increase ROE Hope this helps
I understand, but both of your transactions (increasing retention ratio and/or increasing ROE) is going to increase g (even more). Don’t we want the company growth (g) to come down to the sustainable levels (SGR). I am really missing something very basic here. Call it a brain freeze.
you see swaption, to understand SGR, you must BECOME sgr. hope that helps.
think of g then as your company’s max speed …in order to go over it u must make changes to the make up the determinants in your speed
swaptiongamma Wrote: ------------------------------------------------------- > I understand, but both of your transactions > (increasing retention ratio and/or increasing ROE) > is going to increase g (even more). Don’t we want > the company growth (g) to come down to the > sustainable levels (SGR). > > I am really missing something very basic here. > Call it a brain freeze. roe * retention ratio -is- the sustainable growth rate (edit: at least that’s what i thought) by doing one of those things you’ll be increasing it to catch up with the forecasted rate which is higher edit 2: retention not payout
grr …really? So SGR is the moving target we are trying to achieve, to what we have forecasted (the ‘g’)? I really thought it was the other way round because the firm will eventually settle at the sustainable growth rate, so thought that is what we were trying to achieve.
swaptiongamma Wrote: ------------------------------------------------------- > grr …really? > yes sgr is the growth rate you sustain by reinvesting your earnings (hence roe * retention rate) i think sometimes it’s different from the long-term growth rate you’re given which might be where the confusion is coming from > So SGR is the moving target we are trying to > achieve, to what we have forecasted (the ‘g’)? I > really thought it was the other way round because > the firm will eventually settle at the sustainable > growth rate, so thought that is what we were > trying to achieve. what they’re saying is that when the forecasted growth rate is unattainable with the current roe * reinvested earnings, you have to either retain more earnings or increase return on equity “If the actual growth rate is forecasted to be greater than sustainable growth rate, the firm will have to issue equity unless the firm increases it’s retention ratio, profilt margin, total asset turnover or leverage”
Thank you so much SSS, got it now.
i’m not sure how issuing more equity is going to have the same effect as increasing ROE or retention rate though, maybe someone else can explain it
Had to read it a few times… Sounds like it’s saying, you are growing faster than you thought you were going to grow at. You like it and want more of it. So you need more cash to keep turning the cash cow machine. You have to issue equity, sell stock in the market for cash, to get more cash to magnify this awesome growth. If not, the logical thing to do is keep more of your cash by not paying it out as dividends, increase leverage by borrowing or increase operational efficiency. You keep doing that until you are forced back to your long-term sustainable growth level.
Yeah won’t issuing more equity lower the ROE, since you have a higher denominator in net income/equity?
you guys over complicate things too much. Sustainable growth rate is the internal growth rate with no new equity issued and no change in capital structure. So if the company is going to grow faster then they will need additional funds to do this. This can come through several sources - greater profitability, greater leverage or more equity.