How to Calculate an Expected Growth Rate Using Constant Growth

Those who consistently build a financial portfolio by paying attention and measuring the trends act wisely. True, stock and security investments involve some degree of educated guessing. After all, unforeseen events such as natural disasters, corporate scandals and regulatory policy reversals can upend any previous growth in value. At the same time, many assets enjoy an expansion in worth over long stretches of time.

Accordingly, it is never a bad idea to apply a constant growth rate formula to stocks currently held and those under consideration for acquisition. While surprises may come, a consistent increase in value is a rational assumption all the same.

What Is a Growth Rate?

The idea behind the financial growth rate works much like growth rates in human biology or demographics, for example. Put simply, the degree to which one variable will change over a stated time period. Most important to investors is the year-over-year rate of growth of a company's earnings and revenues, dividends and other payouts and total sales.

Analysts study two categories of growth rate: trailing growth rates, i.e. those that have been previously established, as well as expected growth rates, or those figures that point to future stock performance.

What Does Constant Growth Refer To?

Constant growth is a model by which the inherent value of a stock is evaluated. Also called the Gordon Growth Model (GGM), the constant growth model assumes that dividend values will grow perpetually with each payout. Given this assumption, the GGM is most often applied to companies with stable growth histories in terms of dividends per share.

Its purpose is to convey an idea of what the fair value of a stock should be by excluding market conditions and other variables that cause volatility and otherwise adversely affect a stock's worth.

How Can Constant Growth Give the Expected Growth Rate?

Creating an expected growth rate calculator from the constant growth rate formula begins with the difference between a stock's value at the beginning of the year and that at the year's end. If, then, a share was ​$6​ at the beginning and ​$6.75​ at the end, the difference is +​$o.75​. Using a dividend payment of ​$1.25​ per share in the same year, you then add the difference to the dividend value, yielding ​$​​2​ as the total gain.

Relying on the assumption of constant growth, divide the total gain by the initial price to discover the rate of expected growth. Dividing ​$​​2​ by ​$​​6​ leaves you with ​0.33,​ or about ​33 percent​.

Is It Safe to Assume Constant Growth?

As noted, this assumption is safer, though not fool-proof, for companies that have demonstrated consistent financial expansion, along with a prevailing pattern of dividend payouts, over a number of years. Young companies with recent IPOs are riskier in terms of steady growth expectations. In addition, some companies will keep paying dividends to hold onto investors, even if earnings do not warrant it. In such cases, constant growth is a less dependable inference.

Other Ways to Measure Growth

One of the simplest ways to gauge growth is revenue, annually, quarterly, monthly, etc. Represented as a percentage, revenue is a solid manner to determine whether growth is occurring and how much. Market share, i.e. how much of the market sector a business or product is dominating, is another way to see how well a company is performing.

It is also an indicator of sustainability. Meanwhile, user growth rate captures how many new customers, or how much new business, is gained each month.