How to Calculate Long-Term Growth Rate

The long-term growth rate represents the average pace at which a company’s financial metrics, such as revenue or earnings, are anticipated to increase over an extended period. This metric provides insight into a company’s potential for expansion and profitability. It is important for investors assessing future returns, for management in strategic business planning, and for analysts evaluating valuation models.

Calculating Historical Growth Rates

One method for estimating long-term growth involves analyzing a company’s past performance data through the Compound Annual Growth Rate (CAGR). CAGR provides a smoothed, annualized growth rate over multiple periods, reflecting the compounding effect of growth.

To calculate CAGR, use the formula: ((Ending Value / Beginning Value)^(1 / Number of Years)) - 1. The “Beginning Value” is the financial metric at the start of your chosen historical period, and the “Ending Value” is the same metric at the end. The “Number of Years” represents the total duration. For example, if revenue grew from $10 million to $25 million over five years, the calculation would be ((25 / 10)^(1 / 5)) - 1, resulting in a CAGR of approximately 20.11%.

This method illustrates the consistent growth trend, even if actual year-to-year growth fluctuated. Selecting a relevant historical period, typically five to ten years, is important to ensure the calculated rate reflects a true long-term trend and avoids short-term anomalies. Financial data can be sourced from a company’s publicly available financial statements.

Determining Sustainable Growth Rate

The sustainable growth rate (SGR) offers another perspective on long-term growth, focusing on a company’s ability to grow using its internal resources without issuing new equity or altering its debt-to-equity ratio. This rate assumes a consistent dividend payout policy. It indicates the maximum growth a company can achieve by reinvesting its earnings and maintaining its current financial structure.

The formula for SGR is: SGR = Retention Ratio × Return on Equity (ROE). The retention ratio, also known as the plowback ratio, represents the portion of net income a company retains for reinvestment rather than distributing as dividends. It is calculated as (1 - Dividend Payout Ratio). The dividend payout ratio is determined by dividing total dividends paid by net income.

Return on Equity (ROE) measures how much profit a company generates for each dollar of shareholders’ equity. It is calculated by dividing net income by shareholders’ equity. Both net income and shareholders’ equity figures are found on a company’s financial statements. For instance, if a company has a 60% retention ratio and a 15% ROE, its SGR would be 9% (0.60 × 0.15). This rate suggests the company can sustain a 9% annual growth purely through internal means.

Incorporating Analyst Growth Projections

Beyond historical analysis and internal capacity, external expert estimates provide valuable insights into long-term growth rates. Analyst growth projections are consensus forecasts from financial analysts regarding a company’s future earnings or revenue growth. These projections often cover specific periods, such as the next three to five years, and are based on extensive research and modeling of a company’s prospects.

These projections are readily available from various financial news websites, investment platforms, and brokerage research reports. Investors often look for the average or median consensus estimate for a company’s expected earnings per share (EPS) growth over the long term. This provides a forward-looking view that incorporates current market conditions, industry trends, and company-specific developments.

When utilizing analyst projections, consider the breadth of coverage, as a higher number of analysts often implies a more robust consensus. Examining the consistency of these estimates can offer a sense of their reliability. While analyst projections reflect informed opinions, they are still estimates and should be considered alongside historical performance and sustainable growth capacity for a comprehensive understanding of a company’s potential long-term growth.