Lesson 6 of 8
What a growth rate costs
Growth equals reinvestment times return on capital. One company's filed reinvestment supports 1.04 percent growth, not the 3 percent a model assumes.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Growth is not free. In the model's own identity, growth equals the share of profit reinvested times the return earned on it.
- Procter and Gamble reinvested 5.28 percent of its after-tax operating profit in fiscal 2026, which at its own 19.76 percent return supports 1.04 percent growth.
- Assuming 3 percent growth while leaving the filed cash flow untouched was worth 12.39 a share, and implies a 56.8 percent return on new capital.
Type a growth rate into a DCF and the cash flow grows for free. In the business, growth is bought: a company grows by putting money into itself and earning a return on it. The identity is one line, and running it against the filings is the fastest consistency check there is.
Growth equals reinvestment times return
Run it on a real filing
- After-tax operating profit. Operating income of 19,748 million, an effective tax rate of 20.77 percent from the same statement, so 15,646 million.
- Reinvestment. Capital expenditure of 4,409 million less depreciation and amortisation of 3,160 million is 1,249 million of net new fixed assets. Working capital released 423 million across the two balance sheets, so reinvestment is 826 million.
- The reinvestment rate. 826 over 15,646 is 5.28 percent.
- The return on capital. Shareholders' equity 54,081, plus total debt 35,025, less cash 9,942, gives invested capital of 79,164 million. After-tax operating profit over that is 19.76 percent, which is the figure ValueScreener stores for this company.
- The growth the company is buying. 5.28 percent times 19.76 percent is 1.04 percent a year.
What that does to a 3 percent forecast
The difference is 12.39 a share, a ninth of the answer, and it is invisible in the output. Both models say 3 percent in the growth box.
The other reading of the same gap
Run the identity the other way. Holding reinvestment at the filed 826 million, 3 percent growth requires a return on new capital of 56.8 percent. That is the claim a model makes when it raises growth and leaves the cash flow alone.
Neither reading is automatically wrong. A company can grow without capital for a while, by raising prices, by filling capacity it already has, or by releasing working capital, and Procter and Gamble's revenue did compound at 2.91 percent over the decade to fiscal 2026 on reinvestment near this level. What is wrong is not knowing which of the two you are asserting.
The check to run every time
Take your growth rate, divide by the company's return on capital, and compare the answer with what the company actually reinvests. If your growth needs twice the money the company spends, you have assumed either a change in spending or a change in the return, and both belong in writing next to the model.
Check yourself
In the identity used here, growth equals what?
- Revenue growth times the operating margin
- The share of after-tax operating profit reinvested, times the return earned on that capital
- Capital expenditure divided by depreciation
Show the answer
Answer: B.
Reinvestment rate times return on invested capital. Both halves are readable from the filings, which makes the check quick.A model grows a company at 3 percent while leaving the filed cash flow untouched. What has it implicitly assumed?
- That the discount rate is too high
- That new capital earns far more than the company's current return, here 56.8 percent
- That depreciation exceeds capital expenditure
Show the answer
Answer: B.
Growth without extra reinvestment can only come from a much higher return on the capital being added. That is a strong claim and it is never printed by the model.Why is reinvestment measured as capital expenditure less depreciation, plus the increase in working capital?
- Because depreciation is not a real cost
- Because only spending above the amount that replaces worn-out assets adds capacity, and growth also ties up working capital
- Because the tax rate applies to depreciation
Show the answer
Answer: B.
Replacement spending holds the business where it is. The excess, plus the cash locked into receivables and inventory, is what buys growth.Sources
- Procter and Gamble, Form 10-K, fiscal year ended 30 June 2026, filed 2026-08-04, accession 0000080424-26-000103: operating income, tax, depreciation, capital expenditure, equity, debt, cash and the two balance sheets behind the working capital movement.
- Damodaran, Investment Valuation: expected growth as the reinvestment rate multiplied by the return on invested capital.
- Mauboussin and Callahan, 'The Math of Value and Growth', 2020: growth adds value only when the return on the capital funding it exceeds the cost of that capital.
What this leaves out
- One year of reinvestment is noisy. Capital spending is lumpy and working capital swings, so the rate is better read across several filed years.
- The identity assumes growth comes from capital. Price increases, volume in existing capacity and acquisitions all break it, and acquisitions are excluded from the reinvestment figure above.
- The return on capital used is the product's own recompute for this company, which is an average across all existing capital rather than the return on the next dollar.
- Nothing here is advice about any security.