How is Equity Growth Measured?

What is Growth Rate?

The growth rate of a company is its ability to grow using and investing whatever it has in its operations. The rate is a measure of the capability of a company to have an efficient mechanism of operations that could churns out more profits in two comparable situations.

Like most other ratios, the growth rate is not useful when used alone. For the growth rate to be meaningful, two or more companies should be considered from the same industry. The growth rates of companies also depend on the circumstances that are related to the company’s business.

For example, if the economic conditions are against the business’s growth, the operations of the company may get hurt. That is why the companies have negative growth rates during times of recession.

The growth rate usually paves the future operational path for the companies. When there is a fault in the company’s operations, the management should be able to find out the reason so that the growth rate can be brought back on track.

What is Equity Growth Rate?

The equity growth rate is a measure to understand the funds that get added to equity due to operations. The metric helps stakeholders to check whether equity is increasing or decreasing over time. This is an important tool available for analysts because without an increase in equity it would be cumbersome for the company to grow and meet the debt services as and when required by the company.

The equity growth rate measures the equity pool of a company, and indicates whether the company is crossing the lower level of limit so that the management can take corrective measures if the rate is too low.

Calculation of Equity Growth Rate

$$\mathrm{Equity\: Growth\: rate\, =\, \frac{(Net\: Income\, -\, Stock\: Dividends)}{Shareholder's \: Equity\: Assets}}$$

Hence here,

  • Stock Dividends refer to the dividends that have been issued to both preferred and general shareholders.

  • Shareholder’s Equity is the equity at the beginning of a fiscal year under consideration.

Calculation by Return on Investment (ROI)

Return on investment (ROI) is used when the analysts and investors for the following reasons −

  • Check Company’s Capability

Usually, return on investment (ROI) is used when the analysts and investors want to check whether the company is capable of providing the shareholders with their desired rate of return. This metric can be checked by using various items, such as returns on equity assets, net worth, dividends, and economic value-added.

  • Determines Fair Price for Shareholder

ROI helps analysts determine the fair price to be paid to the shareholders. One of the measures to do so is by checking whether the value of the share is going up or down by looking at the Equity Growth Rate.

The common stock owners are the owners of the company and they will be naturally interested to see if their investment has been made in the correct company. They may also be concerned with the equity they have invested in the business.

  • Determine the Use of Generated

When a profit is gained by a company, it is usually meant for the owners of common stockholders of the company. The board of directors is responsible for determining the use of the money that has been generated as profit. They may decide to keep a portion of the profit and allow another portion to be distributed as dividends. The companies that are in growth mode may not distribute dividends, and keep all of the money generated as profit as retained earnings.

  • Retained Earnings

Retained Earnings are different from stockholder’s equity. The latter is the net value of all money owed to the lenders. It is a better way to judge the value of funds earned by the company because it deducts the distributable money in order to achieve a more meaningful value of funds available for the business owners.

So, dividends are subtracted from net income and the obtained value is divided by the total stockholder’s equity at the start of the same accounting period.

Updated on: 17-May-2022


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