Lesson 313 min

Growth Metrics and Sustainability

Learn to analyze revenue growth, EPS growth, and sustainable growth rates to evaluate company expansion.

Learning Objectives

  • Calculate and interpret revenue growth rates
  • Analyze EPS growth quality
  • Apply the sustainable growth rate formula
  • Understand growth vs. profitability tradeoffs

Growth Metrics and Sustainability#

Growth is essential for stock appreciation—but not all growth is equal. Quality growth is profitable, sustainable, and self-funding. Low-quality growth burns cash, requires constant capital raises, and may never generate returns.

Key Insight: A company growing revenue 30% annually while burning cash is less attractive than one growing 15% profitably. Always evaluate growth quality alongside growth rate.

Revenue Growth Rate#

Calculation#

Revenue Growth Rate = (Current Revenue - Prior Revenue) / Prior Revenue × 100

For multi-year analysis, use CAGR (Compound Annual Growth Rate): CAGR = (Ending Value / Beginning Value)^(1/years) - 1

Example Calculation#

YearRevenueYoY Growth
2021$80B—
2022$92B15%
2023$103B12%
2024$112B9%
3-Year CAGR—11.9%

Growth Rate Benchmarks#

Growth RateAssessment
> 20%High growth (tech, disruptors)
10-20%Strong growth
5-10%Moderate growth
0-5%Mature company
< 0%Declining (red flag)

Revenue Growth Quality Checks#

Not all revenue growth is created equal:

Quality IndicatorGood SignWarning Sign
Organic vs. AcquisitionOrganic growthGrowth only from M&A
Geographic mixDiversifiedSingle market dependent
Customer concentrationBroad customer baseTop 3 customers > 50%
Pricing vs. volumeBalance of bothVolume with price cuts

Acquisition-Driven Growth

Companies can inflate revenue growth through acquisitions. Always check if growth is organic (internal) or acquired. Organic growth is more sustainable and valuable.

Earnings Per Share (EPS) Growth#

Calculation#

EPS Growth = (Current EPS - Prior EPS) / Prior EPS × 100

Use diluted EPS for more conservative analysis.

EPS Growth vs. Revenue Growth#

ScenarioInterpretation
EPS growth > Revenue growthImproving margins and efficiency
EPS growth = Revenue growthStable operations
EPS growth < Revenue growthMargin compression
Negative EPS growthProfitability declining

EPS Growth Quality#

EPS can grow through several mechanisms—some sustainable, some not:

DriverQualitySustainability
Revenue growthHighSustainable
Margin improvementHighDepends on source
Share buybacksMediumLimited by cash
Tax rate reductionLowOne-time benefit
Accounting changesLowNot sustainable

Example: True vs. Artificial Growth#

MetricCompany ACompany B
Revenue Growth12%3%
EPS Growth15%15%
SourceHigher salesBuybacks reduced shares 12%
QualityHighLow

Both show 15% EPS growth, but Company A's growth is far more valuable.

Free Cash Flow Growth#

FCF Growth Is Often More Important

For mature companies, Free Cash Flow growth matters more than EPS growth. FCF can't be manipulated with accounting tricks and shows true cash generation.

Calculation#

FCF Growth = (Current FCF - Prior FCF) / Prior FCF × 100

Comparing Growth Metrics#

MetricWhat It ShowsManipulation Risk
Revenue GrowthTop-line expansionMedium (channel stuffing)
EPS GrowthBottom-line expansionHigh (accounting)
FCF GrowthCash generation growthLow

Sustainable Growth Rate (SGR)#

The SGR shows the maximum growth rate a company can achieve without raising external capital.

Sustainable Growth Rate = ROE × (1 - Dividend Payout Ratio)

Or: SGR = ROE × Retention Ratio

Example Calculation#

MetricValue
ROE18%
Dividend Payout Ratio30%
Retention Ratio70%
Sustainable Growth Rate12.6%

This company can grow at 12.6% annually using only retained earnings.

Interpretation#

ScenarioImplication
Actual growth < SGRCompany is self-funding, may have excess cash
Actual growth = SGROptimal use of internal resources
Actual growth > SGRRequires debt or equity to fund growth

Why SGR Matters#

Growth StrategyFunding SourceRisk Level
Below SGRRetained earnings onlyLow
At SGRRetained earningsOptimal
Above SGR (debt)Earnings + debtMedium
Above SGR (equity)Earnings + dilutionHigh (for shareholders)

Growth vs. Profitability Tradeoffs#

The Growth Dilemma#

Fast growth often requires:

  • Heavy R&D spending
  • Marketing investments
  • Working capital increases
  • Capital expenditures

These reduce near-term profitability for future gains.

Evaluating the Tradeoff#

FactorGrowth-FocusedProfit-Focused
Net MarginLower (investing)Higher (mature)
FCFMay be negativeStrong and positive
ROEOften lowerHigher
ReinvestmentHighLower
ValuationP/E on futureP/E on current

When Growth Investment Makes Sense#

  1. Large addressable market - Room to grow
  2. Competitive moat building - Investment creates barriers
  3. Unit economics work - Each new customer is profitable
  4. Cash runway exists - Won't run out of money

Growth Trap

Some companies grow revenue while destroying value—each dollar of revenue costs more than a dollar to acquire. Check customer acquisition costs against lifetime value.

Industry Growth Benchmarks#

IndustryTypical GrowthNotes
Cloud Software20-40%High growth expected
Technology Hardware5-15%Mature, cyclical
Healthcare8-15%Steady, demographic tailwinds
Financial Services5-10%Tied to economy
Consumer Staples2-5%Low growth, stable
Utilities1-3%Very low, dividend focus

Key Takeaways

  • Revenue growth shows top-line expansion—check if organic or acquired
  • EPS growth can come from revenue, margins, or buybacks—quality varies
  • FCF growth is hardest to manipulate and shows true cash generation improvement
  • Sustainable Growth Rate = ROE × Retention Ratio—max growth without external capital
  • When actual growth exceeds SGR, company needs debt or equity funding
  • Balance growth against profitability—fast growth burning cash isn't always valuable
  • Industry context matters—20% growth is expected in tech but exceptional in utilities

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