SUSTAINABLE GROWTH RATE 7
SustainableGrowth Rate: Apple Inc.
SustainableGrowth Rate: Apple Inc.
AppleInc. was co-founded by Steve Jobs and Steve Wozniak in 1976 thecompany is a leading market leader in mobile technology and computermanufacturing sectors globally (Apple,2016). The many economies of scales and competitive advantages itenjoys allow the company to have a stronger financial status eachyear and compete successfully with other major brands like Samsungand Microsoft. This analysis seeks to appraise Apple’s financialposition especially the firm’s sustainable growth rate (SGR) forthe year 2014, 2015, and 2016 respectively.
SustainableGrowth Rate (SGR)
SGRseeks to determine the maximum growth rate of assets and sales acompany can sustain successfully devoid of increasing its financialleverage or borrowing from external financiers or selling its equity(Wilkinson,2014). Apple Inc. started paying dividends in 2013 stressing the trade-offbetween preserving extra cash to finance future growth anddistributing returns to shareholders. As a mature company, itgenerates free cash flow hence it has excess cash to finance itsgrowth and expansion (Apple,2016). The SGR allows the company to assess its profitability and howpayment of dividends might affect its growth prospects. SGR iscomputed by multiplying the firm’s return on equity (ROE) by thefirm’s percentage of retained earnings.
TheROE is calculated by dividing earnings by the firm’s book value orshareholder’s equity. A higher ROE means the firms is successful inrelations to acquisition and management of assets that generateincome (Wilkinson,2014).Besides, it means the firm can finance its assets through retainedearnings, common stocks, and debts. Higher profit margins, higherlevels of debt comparative to equity, and successful utilization ofassets increases ROE. Retention ratio is computed by subtracting onefrom the payout ratio or the ratio of dividends to EPS (earnings pershare). Retaining all earnings means the ratio is 100% or 1.0. Thehigher the retention ratio and ROE signify a higher SGR. When a firmgo above its SGR, it experiences a decline in growth in the long-termhence it will need to borrow funds to finance the additional growth(Apple,2016).
SGR= ROE x (1 – dividend-Payout ratio).
Whilecalculating SGR, it must be presumed that a firm seeks to sustain atarget capital structure of equity and debt, increase sales, anduphold a static dividend payout ratio.
Barriersrelated to Achievement of Sustainable Growth Rate
Allcompanies pursue to attain the SGR nonetheless, different factorslike consumer trends can impact a firm’s growth and realization ofits optimal SGR (Wilkinson,2014).Poor economic conditions lead to low per capita income andconservatism in spending. As firms compete for such discriminatingcustomers, they reduce their prices which proportionately affecttheir growth. Furthermore, a firm can seek to invest heavily in newproduct development to attract new customers and keep the existingones. The strategy ultimately affects the firm’s capacity to growand realize its SGR (Hahn,2014).
SustainableGrowth Rates: 2014 to 2016 (Apple,2016)
TheSGR is measured as:
SGR= Return On Equity (ROE) x Retention Ratio
RetentionRatio = 1 – dividend payout ratio
Inthe case of Apple, the calculations below provide values of SGR forthe periods 2013, 2014 and 2015:
SGR(2014) = 0.35 x (1 – 0.285) = 0.25
SGR(2015) = 0.45 x (1 – 0.215) = 0.35
SGR(2016) = 0.36 x (1 – 0.281) = 0.26
Theabove analysis shows that Apple’s SGR increased from 2014 to 2015but reduced in 2016. The fluctuations can be attributed to itsdividend payout ratio and profitability since it determines itsretained earnings which are meant to be reinvested for corporategrowth and growth purposes (Wilkinson,2014). Apple’s revenue growth rates from 2014 to 2016 were 6.95%, 27.95%,and -7.73% respectively. The company’s actual growth rates yearlyare below its SGR meaning the firm functions below its optimallevels. The average SGR can be computed as:
SGR= 0.92x (1 – 0.25) = 0.69 or 69%
TheSGR (69%) is favorable considering Apple Inc. is a very big company.There is greatly stability in its dividends hence the companyincreases its dividends it pays to its shareholders as well as offsetany impacts of inflation (Hahn,2014).The company has reinvested billions of dollars in its businessreturn on assets was 14.93% while return on equity was 36.9% in 2016.Inflation, economic, political, consumer trends, and competitive canaffect its SGR requiring it to seek external finances. Alternatively,consistent growth will allow the company to self-finance itscorporate strategy. Its customers can support a favorable SGR with ahigh level of disposable income (Rawlinson, 2016). Hence, the firmmust persistently invest in research and development and supply chainmanagement to increase the sales volume.
Inconsistencyin Actual Growth and Sustainable Growth Rate
Greatchallenges can be experienced when the actual growth rate surpassesthe SGR for instance there can be increased uncontrolleddevelopments. The actual growth rate must not exceed SGR since itultimately affects its debt and equity (Wilkinson, 2014). A poor SGRis caused by increased external borrowing. The firm must ensure itsexternal debt does not surpass the firm’s equity as it affects itscreditworthiness. Apple Inc. must focus on growth capability as wellas the growth strategy to increase its SGR to higher levels. IfApples Inc. grows at a rate that exceeds its SGR, it might be forcedto source external funds to match the growth (Hahn,2014).Future financial strategies might require Apple Inc. to selladditional equity. The firm can be hesitant to issue additionalequity as the high costs of selling equity and the prospective ofdiluting earning per share.
Excessivegrowth leads to financing challenges hence, the business might beforced to borrow to increase financial leverage. The firm also mightfail to sustain a target capital structure without selling newequity. Besides, it might fail enhance its sales volumes or sustain atarget dividend payment ratio to match market conditions (Hahn,2014).The firm must strive that the retained earnings act as a source ofnew equity. In consistent to SGR, many companies stop selling newequity. When a company fails to self-fund its growth, it mustformulate a financial strategy that enhances its financial leveragethrough debt, improving profit margins, cutting dividend payouts,selling additional equity, or decreasing its asset to sales ratio toenhance its SGR (Hahn,2014).Additionally, an optimal SGR can be achieved by increasing prices,liquidating marginal operations, or improving production and supplychain efficiencies to boost its profit margin. Furthermore, AppleInc. can seek to outsource its activities along the value chain toimprove its asset turnover ratio (Wilkinson,2014).The firm should not opt to reduce its dividends as it might impactits stock price negatively.
FinancingExcessive Growth or Rewarding Stockholders for Under Performance
Incases whereby the optimal SGR and the actual growth rate areinconsistent the firm is forced to explore alternative strategies togive benefits to the company’s stockholders (Peavler,2016). The firm’s principal goal is establishing productive ways touse the extra cash flows generated through excessive growth. The cashflows can be beyond their needs. Management can opt to return thefunds to stockholders through common stock repurchases, cutting thecompany’s debt load, increasing dividends, or increasing ownershipof reduced earning liquid assets. These strategies are meant toreduce the SGR (Wilkinson,2014).If Apple Inc. growth rate is less than its SGR, it can reward itsshareholders by repaying them some cash especially through suchstrategies as large share buyback or introducing regular dividend.Alternatively, Apple Inc. can seek to improve its actual growth ratesby acquiring rapidly growing companies.
Analysisof Apple’s SGR proves that the firm seeks to sustain an optimalgrowth rate each fiscal year. Despite increasing competition, thefirm capitalizes on its competitive advantages to increase its netincome to finance its expansion and growth strategies withoutexternal borrowing. Apple’s SGR is determined by its capitalstructure and operational efficiencies.
AppleInc.(2016).AnnualReport on Form 10-K. Retrieved fromhttps://goo.gl/04JYLb
Hahn,J. (2014). The Sustainable Growth Rate (SGR) and Medicare PhysicianPayments: Frequently Asked Questions. CongressionalResearch Service.
Peavler,R. (2016). Whatis the Sustainable Growth for a Business? Retrieved fromhttps://goo.gl/COQoucWilkinson,J. (2014).SustainableGrowth Rate. Retrieved from https://goo.gl/1DdP33