Old Thoughts on New Growth Rates

Abstract

It is not the purpose of this essay to question the wisdom or discuss the techniques of projecting growth rates. Instead, it is to emphasize the two basic factors involved, profitability and dividend payout, and, through this means, to consider what may be reasonable limits to maximum projected rates of growth. requirements for achieving any particular rate may be determined from the accompanying graph. Of the two determinants, one is often a part of company policy and at least theoretically is fully controllable by management. A business can, of course, raise earnings by selling common stock, for it then has more assets on which to earn a return. impact on per share earnings depends on the relationship of the selling price to the book value per share as well as on the rate of return to be realized. It is also possible to add to earnings through the sale of debt, when the cost of the money borrowed is less than the return it produces. While important, an increase in earnings generated in either of these ways is not meant here to be quite the same thing as a change in the rate of growth, and within the narrow scope of these comments it is best ignored. (Other aspects of the leverage and financing effects may be found in such articles as The Mechanics of Corporate Growth by Robert I. Cummin in the August 1957 issue of Analysts Journal [now Financial Analysts Journal] and Debt Financing and Investment Value of Common Stock by Sanford L. Margoshes in the JulyAugust 1962 issue of the same publication). Similarly, other essentially nonrecurring developments, such as a lowering of capital costs through refunding, should also be excluded. For the remainder of this discussion, it is assumed that capitalization ratios and the cost of senior capital remain constant, with a variation in the return on common stock equity arising only from a change in the profitability of the business enterprise. movement of earnings during such a change will also be disregarded.