Growth can come from two sources: increased volume and inflation. The inflationary increase in assets must be financed as though it were real growth. Inflation increases the amount of external financing required and increases the debt-to-equity ratio when this ratio is measured on a historical cost basis. Thus, if creditors require that a firm's historical debt-to-equity ratio stay constant, inflation lowers the firm's sustainable growth rate. Gallinger, George W. April Galpin, Timothy. Sowinski, Lara L.
While demand in the sector remains strong, the state of the nation's infrastructure is threatening to put the brakes on sustainable growth.
What is the Sustainable Growth Rate Formula?
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Investors may prefer the PEG ratio because it explicitly puts a value on the expected growth in earnings of a company. The PEG ratio is less appropriate for measuring companies without high growth.
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Large, well-established companies, for instance, may offer dependable dividend income, but little opportunity for growth. A company's growth rate is an estimate. It is subject to the limitations of projecting future events.
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Future growth of a company can change due to any number of factors: market conditions, expansion setbacks, and hype of investors. The simplicity and convenience of calculating PEG leaves out several important variables.
First, the absolute company growth rate used in the PEG does not account for the overall growth rate of the economy, and hence an investor must compare a stock's PEG to average PEG's across its industry and the entire economy to get any accurate sense of how competitive a stock is for investment. A low attractive PEG in times of high growth in the entire economy may not be particularly impressive when compared to other stocks, and vice versa for high PEG's in periods of slow growth or recession.
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In addition, company growth rates that are much higher than the economy's growth rate are unstable and vulnerable to any problems the company may face that would prevent it from keeping its current rate. Therefore, a higher-PEG stock with a steady, sustainable growth rate compared to the economy's growth can often be a more attractive investment than a low-PEG stock that may happen to just be on a short-term growth "streak".
A sustained higher-than-economy growth rate over the years usually indicates a highly profitable company, but can also indicate a scam, especially if the growth is a flat percentage no matter how the rest of the economy fluctuates as was the case for several years for returns in Bernie Madoff's Ponzi scheme.
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What is Sustainable Growth Rate?