Growth Rates
Growth rates indicate the change in the value of any economic or statistical variable at the moment in comparison with its initial value for a certain period of time. It is normally measured in percentages. For investors, growth rates are defined as a percentage increase in income earned by a business, profit, dividends, concepts of macroeconomics, for example GDP, over a year.
Growth Rates explained
Growth rates are an increase in the value of any variable over the period of time (usually over one year) as a percentage. An economy's growth rate is determined by the total amount of revenues collected by governments or gross domestic product (GDP). If GDP is growing, then the economy is developing and growing. It is essential to calculate the rate of economic growth, for instance, to measure the decline in economic performance.
We can talk about the recession if there is a decline in GDP and revenues of the country for 2 quarters in a row. And if there is an increase in revenue for 2 quarters, it means that the country is expanding.
Formula and calculation
There are several ways to calculate growth rates. A simple growth rate indicates the intensity of changes in a process in comparison with its initial (basic) value. The formula used for the simple growth rate is:
To calculate the economic growth rate, the following formula can be used:
What is CAGR
CAGR, or compound annual growth rate, refer to the annual rate at which an investment should grow from its initial balance to its final value over a certain period of time. The CAGR is calculated, provided that the income is reinvested every year. It is important to understand that compound annual growth rate is an approximate rate and not a true return rate. To measure CAGR, we can use the formula below:
The calculation of this rate assumes that there was a continuous growth during the particular period of time.
Dividend growth and securities valuation
According to financial theory, an organization’s stocks can be evaluated with the help of a dividend discount model (DDM). This model relies on the concept of time value of money. It demonstrates that the stock value is equal to the value of future dividends at the present time. In other words, you predict the amount of the company's future dividends and discount them, getting the fair value of the stock.
The Gordon Growth Model (GGM) is the simplest model used for estimating the intrinsic value of a stock taking into consideration future dividends that will presumably grow at a constant rate for an unlimited period of investment. It is supposed that the rate of growth of a particular stock's dividend over time will be positive as organizations want investors to rely on increasing dividends. That’s why the dividend growth rate influences the valuation of a company's shares.
When to use Growth Rates
Growth rates of an organization. Analysts use such indicators to understand how a business increased its amount of profit and predict future financial and non-financial characteristics of the company. The growth rates allow them to evaluate the increase in the capital of the enterprise over a period of time. Auditor’s reports and other reports are based on the calculation of the growth rates. It indicates the business performance. Investors also pay attention to growth rates for price-to-earnings ratios or book value.
The internal growth rate (IGR) refers to the maximum rate that an organization could grow with only retained earnings and without external financing.
Growth rates of an industry. There is also an opportunity to calculate the growth rates of a particular industry. Unique benchmark number was set for each of them, and we can rely on it to evaluate the industrial efficiency. For example, organizations that operate in the leading and innovative IT industry tend to have higher growth rates than businesses that are conducted in an industry that is not likely to grow quickly in the future. It may be useful for companies that want to compete in the market as they can compare their performances with other businesses.
Taking into account historical growth rates, you can make predictions about how the industry will grow in the future. Nevertheless, if the rates are currently growing, it doesn’t mean that this trend will continue in the future as the state of affairs in the overall economy of the country can change at any moment.
Retail sales growth is also defined as a significant growth rate as it gives information about the level of optimism of consumers regarding the state of a country's economy and their own income. It has a positive impact on GDP and if there is a positive growth, it indicates that people are ready to spend more money on goods and services. If the economy experiences a recession, retail sales usually drop.
