Reinvestment Rate and Sustainable Growth: Why Some Companies Can Pay Dividends While Growing

by Karnivesh | 29 January 2026

A CFO presents two investment opportunities to a board. Company A reinvests 40% of earnings while paying 60% as dividends. Company B reinvests 90% of earnings and pays virtually no dividends. Which is growing faster? The reflexive answer: Company B, obviously. But then the CFO reveals the ROCE (Return on Invested Capital): Company A earns 37% on reinvested capital; Company B earns 8%. Suddenly, the answer reverses. Company A paying dividends while reinvesting less is growing faster because each rupee of reinvestment is far more productive.

Understanding the relationship between reinvestment rate and sustainable growth is the key to identifying high-quality businesses. It separates companies that compound wealth from those that simply retain capital without generating proportional returns. For Indian investors, this distinction is particularly critical.

What is Sustainable Growth Rate?

The Sustainable Growth Rate (SGR) is the maximum rate at which a company can grow using only internally generated cash, without external financing. It's calculated simply: SGR = ROE × Retention Ratio (or SGR = ROE × (1 – Dividend Payout Ratio))

If a company has 20% ROE and retains 60% of earnings (paying 40% dividend), its sustainable growth rate is 12%. The company can theoretically grow 12% annually without issuing equity or accumulating excessive debt.

The critical insight: sustainable growth isn't driven by how much a company reinvests; it's driven by how productively it deploys that reinvestment. A company earning 40% ROCE on reinvested capital can grow faster while paying higher dividends than one earning 10% ROCE despite reinvesting more.

The Indian Reality: How Quality Companies Differ

The chart reveals why different Indian companies have vastly different growth potential despite similar-looking capital structures. Asian Paints achieves 13.4% revenue growth while reinvesting only 42% of earnings and paying 58% as dividends. This is possible because its ROCE is 37% each rupee reinvested generates exceptional returns. The company doesn't need to hoard capital; it can distribute it to shareholders while still growing.

Contrast this with Bajaj Finance, which reinvests 87% of earnings (paying only 13% dividends) and grows at 25%+. The difference: Bajaj Finance has 20% ROCE, substantially lower than Asian Paints but still above its cost of capital. By retaining more earnings, the NBFC can achieve faster growth despite lower return on capital.

Hindustan Unilever operates with 95% ROE and 85% ROCE extraordinary returns. Yet it reinvests only 25% of earnings, paying 75% as dividends. Why? Because the business is mature and doesn't need much capital to grow. Each rupee retained is so productive that the company can afford to return most cash to shareholders while sustaining 10%+ growth.

The key difference: reinvestment alone doesn't determine growth. ROCE does. A company reinvesting 100% of earnings at 8% ROCE grows only 8%. A company reinvesting 30% at 40% ROCE grows 12%. The quality of capital deployed matters more than the quantity of capital deployed.

The Sustainable Growth Formula: When Reality Exceeds Theory

The formula SGR = ROE × Retention Ratio works perfectly under stable conditions. Shree Cement's SGR is 9.74% based on its financial metrics. But in FY24, the company achieved 14.29% sales growth exceeding its SGR. How is this possible?

Three mechanisms allow companies to exceed their SGR temporarily:

First, they can reduce debt. Shree Cement paid down ₹1,065 crores in debt while simultaneously investing ₹3,071 crores in capex and paying ₹379 crores in dividends. The company can grow faster because it's using leverage reduction (deleveraging) to fund growth. This is sustainable only if debt levels are excessive initially.

Second, they can increase working capital efficiency. Companies with improving cash conversion cycles (like those with negative working capital) generate cash that exceeds the SGR formula's predictions. The cash windfall from improved working capital can fund growth beyond SGR.

Third, they can access external financing if growth opportunities exceed internal cash generation. Reliance Industries invests substantially beyond what retained earnings alone would support because external capital is readily available. The trade-off: leverage increases, raising financial risk.

The Marcellus Investment Approach: Practical Application

One of India's most successful investment strategies Marcellus's "Capital Compounder Program" (CCP) applies these principles systematically. The portfolio targets companies with:

• ROCE >20% (high capital efficiency)

• Reinvestment rate 35-50% (moderate, not excessive)

• Revenue growth aligned with operational quality

The result: 20-30% annualized returns since inception, substantially outperforming the Sensex. How? By identifying companies where high ROCE + moderate reinvestment generates faster growth than investors expect, creating valuation gaps. Asian Paints with 37% ROCE and 42% reinvestment is precisely this profile.

The approach avoids two traps. First, companies with low ROCE despite high reinvestment (growth startups spending heavily but earning minimal returns). Second, mature companies with high ROCE but zero reinvestment (no growth despite excellent returns). The sweet spot: high ROCE + disciplined, moderate reinvestment.

Why This Matters for Dividend Policy

Understanding sustainable growth transforms how we view dividend policy. A company paying 70% dividends while maintaining 15% growth appears reckless until you discover its ROCE is 50%. Then it appears disciplined the company is returning excess cash because reinvestment opportunities are limited.

Conversely, a company paying 5% dividend while growing only 8% appears miserly until you discover its ROCE is 10%. Then it appears incorrect the company is failing to generate returns justifying capital retention, yet still hoarding cash. Shareholders would be better served receiving dividends and reinvesting elsewhere.

The highest-quality companies adjust dividend policy to their growth stage and ROCE. Asian Paints and Hindustan Unilever pay high dividends because their ROCE is so exceptional that reinvestment needs are limited. Bajaj Finance retains earnings aggressively because its growth rate (25%+) exceeds what lower reinvestment would support.

Red Flags: When High Reinvestment Is Concerning

Watch for companies with sustained high reinvestment (>80%) but declining ROCE. This pattern suggests reinvestment is generating diminishing returns. The company is accelerating investment spending without corresponding return improvement a classic sign of capital misallocation.

Similarly, flag companies where actual growth significantly lags sustainable growth projection. If SGR is 12% but actual growth is 5%, capital is being wasted. The company is retaining earnings but failing to deploy them productively.

Finally, watch for companies where dividend yield plus growth rate is declining despite high reinvestment. This combination suggests the business is deteriorating rather than improving.

The Investor's Playbook

When evaluating Indian companies, calculate SGR and compare it to actual growth. If actual growth >SGR, investigate why (is it temporary? leveraged? or improved efficiency?). If actual growth <SGR, something is wrong with capital allocation.

Compare reinvestment rate across industry peers. Companies with lower reinvestment rates but equal/higher growth rates are more capital-efficient and deserve premium valuations. Compare ROCE across peers regardless of reinvestment rate higher ROCE companies create more value per rupee deployed.

Finally, consider dividends in context. A company paying 5% dividend yield with 15% SGR is retaining substantial capital; higher dividends would be justified unless management has high-return growth opportunities. Conversely, a company paying 3% dividend with 3% SGR is destroying value paying out too little despite generating minimal growth.

The Bottom Line

Reinvestment rate and sustainable growth are directly connected through ROCE: Growth = ROCE × Reinvestment Rate. A high-quality company is one where this equation is dominated by high ROCE, not high reinvestment. It can grow quickly while paying dividends because each rupee of capital deployed is highly productive.

The best Indian stocks Asian Paints, Hindustan Unilever, Bajaj Finance share a common characteristic: they compound shareholder wealth through superior ROCE, not capital hoarding. Understanding this distinction separates long-term investors from those chasing superficial metrics. Quality compounds; volume dilutes.