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One method to estimate the rate at which a company will grow


In our Returns On Capital article, we gave the following formula:

Free Cash Flow is approximately equal to:

Net Income X (Return on Equity - Growth Rate)
_______________________________________________
(Return on Equity)

If we rearrange this formula, we can calculate a company's estimated growth rate.

Let's do a little bit of algebra. We'll set F equal to free cash flow, N equal to net income, G equal to growth rate and R equal to return on equity. This gives us:

F =

N(R-G)
_____________________________
R

F =

NR - NG
_____________________________
R

RF =

NR - NG

R(F-N) =

-NG


-R(F-N)
__________________ =
N

G


G =

R(N-F)
__________________
N

Which gives us:
Growth Rate is approximately equal to:

Return on Equity(Net Income - Free Cash Flow)
______________________________
Net Income