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Costco - Sustainable growth model, 1997-2001 Sustainable Growth Model [NOTE: For all steps, refer to the accompanying Sustainable Growth Tables" of ratio calculations
the prime mover" Consumer Pull", however, seems to be the most important driving factor behind the sustenance of the industry. The purchasing power of the customers
Submitted by reindeergirl on December 2, 2007
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Sustainable Growth Model
[NOTE: For all steps, refer to the accompanying Sustainable Growth Tables" of ratio calculations for Costco and its competitors for all years measured. The table are located at the close of this section.]
The sustainable growth rate is the rate at which a firm can grow while keeping its profitability and financial policies unchanged. The model allows an analyst to isolate drivers that have led to changes in historical growth in order to isolate causes of change. It is represented in four steps.
Step 1: Profitability and Earnings Retention
At the end of each year the return that Costco realizes on equity capital can either be reinvested back into the business or paid out to investors as dividends and common stock repurchases. If no dividends or share repurchases were made and earnings were reinvested back into the business at the same incremental rate of return, the company's return on equity would hold constant over time. In reality, most companies, including Costco, frequently experience changes in their return on equity, and distribute some portion of earnings to investors. Therefore, at the highest level, sustainable growth rate for Costco and its competitors can be expressed as the product of the following two ratios:
∑ Earnings Retention Ratio = 1 Dividend Payout Ratio
∑ Return on Equity (ROE) = Net Income / Owner's Equity
As demonstrated in the accompanying tables, both Costco and Wal-Mart Corp retained all of their earnings for the periods 1997 through 2001 so their dividend payout ratio is 0 and its earning retention ratio is 1. This means that both Costco and Wal-Mart Corp. retain 100% of earnings therefore paying out 0% in dividends, which is indicative of rapidly expanding companies.
If Costco paid out some of its earnings in dividends, like Sears or BJ's Wholesale, its earnings available for reinvestment in the...
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