The Retention
Rate of Dividend & the Self-Sustainable
Growth (SSG)
SSG = ROE
. Retention Rate of Dividend (RR)
SSG is the
rate of growth that a company can maintain (can
sustain) internally without changing its financial
structure (D/E).
The basic
question is therefore : given
the firm's characteristics how large a growth
rate can it support without distorting its D/E
ratio and without raising additional outside
equity capital ?
Example :
|
n
= 0 |
n
= 1 |
n
= 2 |
Annual
SSG |
Debts |
500 |
540 |
583.2 |
8 % |
Equity |
500 |
540 |
583.2 |
8 % |
Assets |
1000 |
1080 |
1166.4 |
8 % |
D/E |
1.0 |
1.0 |
|
|
Net profit |
100 |
108 |
|
|
ROE |
20 % |
20 % |
|
|
Retention
rate of Dividend |
40 % |
40 % |
|
|
Dividend
Payout Ratio |
60 % |
60 % |
|
|
At time n = 1, the equity of the
firm is going to increase by 40. The firm could,
without changing its D/E ratio, add 40 to its
existing debt. The Asset base of the company
could therefore increase by 80, which means
8 % of the starting 1000 base.
How can we increase SSG
? Essentially by acting on 2 parameters :
Improving ROE
: it requires 3 types of action, as we have
seen earlier :
Improving the operating margin
improving the asset turnover
improving the leverage factor
Increasing
the profit retention rate (which means decreasing
the Dividend Payout Ratio)
Some companies are constrained
to accept a low rate of growth (while their
competitors are able to growth at a much higher
rate) because of a basic weakness in their ROE
(often combined with a rather high dividend
payout ratio). No surprise that they have a
hard time competing and maintaining their market
shares.
We can decompose the formula
as follow :
(SSG is the only
growth rate in sales that is consistent with
stable values of the 4 ratios)
SSG
= |
ROE
|
x |
RR |
SSG
=
|
Profit |
x
|
Sales |
x
|
Assets |
x
|
RR
|
Sales |
Assets |
Equity |
Financial policies
The [Assets / Equity ]
ratio reflects the policy regarding the financial
leverage.
The RR reflect
the management attitude towards the distribution
of dividend.
Operating performances
The Profit Margin
& the Asset
Turnover reflect the operating
performances of the business.
Sources :
Financial Leverage,
the CAPM and the Equity cost of capital, 1999,
Marc Bertonèche, Ph. D. in Finance from
the Northwestern University, Professor at the
Bordeaux University and at Sciences-PO Paris,
Visiting Professor at Harvard Business School
and Oxford University.
Interpreting
and using financial statements, 1999,Marc Bertonèche, Ph. D. in Finance from
the Northwestern University, Professor at the
Bordeaux University and at Sciences-PO Paris,
Visiting Professor at Harvard Business School
and Oxford University.
Principles of Corporate Finance, 8th edition, Richard A. Brealey & Stewart C. Myers, McGraw-Hill
Corporate
Finance Course, Bernard Jaquier, Professor
in Economics & Finance, Lausanne, Switzerland, 2018