Everything in the DuPont analysis reads a year that has already happened. The same identity also answers a forward question, the one a lender, a board and a valuation all ask. How fast can this company grow on its own money?
How is the sustainable growth rate calculated?
Growth consumes assets. A firm that grows revenue 20% at a constant asset turnover needs 20% more assets, and those assets must be paid for by retained profit, new equity, or new debt. Hold the capital structure fixed and refuse new equity, and only one source is left. The sustainable growth rate is the growth in equity that retained earnings alone can fund:
g = b × ROE where b = retention = 1 − payout ratioSubstitute the 3-step DuPont for ROE and the identity opens into four named factors, which the CFA curriculum labels PRAT:
g = P × R × A × T
= net margin × retention × asset turnover × financial leverageProfitability, retention, activity, leverage. The letters are a mnemonic. The content is the same decomposition as in the 3-step DuPont, with a payout decision bolted on the front. Two of the four factors are operating (margin and turnover) and one is financing (leverage). The fourth, retention, is a board decision made in a single meeting each year. That asymmetry is why it's worth computing. Three levers take years to move, and the fourth moves in an afternoon.
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Worked example: same growth, opposite routes
Two synthetic Indian companies, both retaining 60% of profit, reach the same sustainable growth rate by opposite routes.
| Neelkanth Speciality (chemicals) | Bharat Depot (distribution) | |
|---|---|---|
| Net margin (P) | 18.0% | 3.0% |
| Retention (R) | 0.60 | 0.60 |
| Asset turnover (A) | 0.70× | 3.20× |
| Financial leverage (T) | 1.60× | 2.10× |
| ROE = P × A × T | 20.16% | 20.16% |
| Sustainable growth = R × ROE | 12.10% | 12.10% |
On a screen the two firms would sit on the same line, and they aren't the same animal at all. Differentiate the identity one factor at a time and the fragilities separate. One percentage point off Neelkanth's net margin costs it 0.67 points of sustainable growth. The same point off Bharat Depot costs 4.03 points, because Bharat Depot's margin is spread over 3.2 turns of assets. Now run the test on turnover. A move of 0.10× in asset turnover is worth 1.73 points of growth to Neelkanth and 0.38 points to Bharat Depot. A price war is an existential event for the distributor and a bad year for the chemical maker. A working-capital blow-out is the reverse.
How do you test a growth forecast against it?
Read the gap between actual and sustainable growth as a funding statement. It isn't a verdict. Take Neelkanth growing revenue at 18% on ₹2,000 crore of sales. It holds assets of 2,000 ÷ 0.70 = ₹2,857 crore and needs ₹514 crore of new assets to support the year. Its retained profit funds ₹346 crore of that. The residual ₹169 crore has to arrive as debt. Debt raises T, and with it next year's sustainable growth and next year's risk. Or it arrives as equity, which dilutes. Or the company doesn't grow that fast. Sustained growth above g without either is arithmetically impossible, so the comparison makes a useful lie detector for a management guidance deck. Growth persistently below g is the opposite problem. The company is piling up equity it can't deploy, and the payout ratio is the conversation to have.
What are the limits of the sustainable growth rate?
Valuation takes this identity into terminal value. There g becomes the perpetual growth rate a firm can fund forever, and the cap on it comes from the discount-rate stack, not from this arithmetic. Two limits keep the two uses apart. First, g holds turnover and leverage constant, so a company that's really improving either one can beat it for years without financing anything. Second, ROE here is the reported ROE, with every distortion catalogued in the limits of ROE still inside it. A leverage-led 20% ROE produces a leverage-led sustainable growth rate, and the identity won't tell you the tank is nearly empty.