Growth Rates

What Are Growth Rates?

Growth rates refer to the percentage change of a specific variable within a specific time period. For investors, growth rates typically represent the compounded annualized rate of growth of a company's revenues, earnings, dividends, or even macro concepts, such as gross domestic product (GDP) and retail sales. Expected forward-looking or trailing growth rates are two common kinds of growth rates used for analysis.

Understanding Growth Rates

At their most basic level, growth rates are used to express the annual change in a variable as a percentage. An economy's growth rate, for example, is derived as the annual rate of change at which a country's GDP increases or decreases. This rate of growth is used to measure an economy's recession or expansion. If the income within a country declines for two consecutive quarters, it is considered to be in a recession.

How to Calculate Growth Rates

Growth rates can be calculated in several ways, depending on what the figure is intended to convey. A simple growth rate simply divides the difference between the ending and starting value by the beginning value, or (EV-BV)/BV. The economic growth rate for a country's GDP can thus be computed as:

Economic Growth = GDP 2 − GDP 1 GDP 1 where: GDP = Gross domestic product of nation \begin{aligned} &\text{Economic Growth} = \frac { \text{GDP}_2 - \text{GDP}_1 }{ \text{GDP}_1 } \\ &\textbf{where:} \\ &\text{GDP} = \text{Gross domestic product of nation} \\ \end{aligned} Economic Growth=GDP1GDP2−GDP1where:GDP=Gross domestic product of nation

This approach, however, may be overly simplistic.

A common modification is the compound annual growth rate (CAGR, which is not a true return rate, but rather a representation that describes the rate at which an investment would have grown if it had grown the same rate every year and the profits were reinvested at the end of each year. The formula for calculating CAGR is:

C A G R = ( E V B V ) 1 n − 1 where: E V = Ending value B V = Beginning value n = Number of years \begin{aligned} &CAGR= \left ( \frac{EV}{BV} \right ) ^{\frac{1}{n}}-1\\ &\textbf{where:}\\ &EV = \text{Ending value}\\ &BV = \text{Beginning value}\\ &n = \text{Number of years} \end{aligned} CAGR=(BVEV)n1−1where:EV=Ending valueBV=Beginning valuen=Number of years

The CAGR calculation assumes that growth is steady over a specified period of time. CAGR is a widely used metric due to its simplicity and flexibility, and many firms will use it to report and forecast earnings growth. 

Dividend Growth and Securities Valuation

Financial theory suggests that a company's shares can be fairly valued using a dividend discount model (DDM), based on the hypothesis that present-day price is worth the sum of all of its future dividend payments when discounted back to their present value. As a result, dividend growth rates are important for valuing stocks.

The Gordon Growth Model (GGM) is a popular approach used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate. This dividend growth rate is assumed to be positive as mature companies seek to increase the dividends paid to their investors on a regular basis. Knowing the dividend growth rate is thus a key input for stock valuation.

Using Growth Rates

Company and Investment Growth Rates

Growth rates are utilized by analysts, investors, and a company's management to assess a firm's growth periodically and make predictions about future performance. Most often, growth rates are calculated for a firm's earnings, sales, or cash flows, but investors also look at growth rates for other metrics, such as price-to-earnings ratios or book value, among others. When public companies report quarterly earnings, the headline figures are typically earnings and revenue, along with the growth rates — quarter over quarter or year over year — for each. 

Amazon, for example, reported full-year revenue of $232.89 billion for 2018; this represented growth of 30.93% from 2017 revenue of $177.9 billion. Amazon also reported that its earnings totaled $10.07 billion in 2018, compared to $3.03 billion in 2017, so the firm's growth rate for earnings on a year-over-year basis was a whopping 232%.

The internal growth rate (IGR) is a specific type of growth rate used to measure an investment's or project's return or a company's performance. It is the highest level of growth achievable for a business without obtaining outside financing, and a firm's maximum internal growth rate is the level of business operations that can continue to fund and grow the company.

Because stock prices are thought to reflect the discounted value of a firm's future cash flows, a rising stock market implies improving forecasted growth rates for the company.

Industry Growth Rates

Specific industries also have growth rates. Each industry has a unique benchmark number for rates of growth against which its performance is measured. For instance, companies on the cutting edge of technology are more likely to have higher annual rates of growth compared to a mature industry such as retail. Industry growth rates can be used as a point of comparison for firms seeking to gauge their performance relative to their peers.

The use of historical growth rates is one of the simplest methods of estimating the future growth of an industry. However, historically high growth rates do not always indicate a high rate of growth looking into the future as industrial and economic conditions change constantly and are often cyclical. For example, the auto industry has higher rates of revenue growth during periods of economic expansion, but in times of recession, consumers are more inclined to be frugal and not spend disposable income on a new car.

Example of Growth Rates

In addition to GDP growth, retail sales growth is another important growth rate for an economy because it can be representative of consumer confidence and customer spending habits. When the economy is doing well and people are confident, they increase spending, which is reflected in retail sales. When the economy is in a recession, people reduce spending, and retail sales decline.

For example, Q2 2016 retail sales growth for Ireland was reported in July 2016, revealing that domestic retail sales flatlined through the second quarter of the year. It is believed that political instability within the country, combined with the results of the Brexit vote in June 2016, caused Ireland's sales to stall. While some industries, such as agriculture and garden, showed positive growth, other industries within the retail sector counteracted that growth. Fashion and footwear had negative growth for the quarter.

Frequently Asked Questions

 How Do You Calculate the Growth Rate of a Company?

Company growth can be measured along several dimensions, but all will follow the same basic approach, which is taking the difference between the current and former level and dividing that amount by the former level. Thus, we can judge a company's profit growth by comparing its bottom line in the current period versus the prior one. Analysts also consider sales (revenue) growth, stock price appreciation, and dividend growth in a similar manner.

How Do You Calculate Growth Rate in Excel?

Since growth rate calculations follow a fairly straightforward formula, they can be easily transported into a spreadsheet program like MS Excel in order to speed up calculations and remove the chance of human error. You will simply need to provide the beginning values, ending values, and the number of periods (if using CAGR, for instance). Note that newer versions of Excel also have a built-in rate of return function that can compute CAGR in one step, known as [RRI]. Still, the RRI function uses three arguments: number of periods, start value, and end value.

How Do You Calculate the Growth Rate of an Investment?

Investors often look to rate of return (RoR) calculations to compute the growth rate of their portfolios or investments. While these generally follow the formulae for growth rate or CAGR, investors may wish to also know their real or after-tax rate of return. Thus, growth rates for investors will net out the impact of taxes, inflation, and transaction costs or fees.

How Do You Calculate GDP Growth Rate?

The GDP growth rate, according to the formula above, takes the difference between the current and prior GDP level and divides that by the prior GDP level. The real economic (GDO) growth rate will take into account the effects of inflation, replacing real GDP in the numerator and denominator, where Real GDP = GDP / (1 + inflation rate since base year).

How Do You Calculate the Growth Rate of a Population?

Like any other growth rate calculation, a population's growth rate can be computed by taking the current population size and subtracting the previous population size. Divide that amount by the previous size. Multiply that by 100 to get the percentage.