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

Intermediate Topics

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