The dividend growth rate is the annualized percentage rate of growth that a particular stock's dividend undergoes over a period of time. Many mature companies seek to increase the dividends paid to their investors on a regular basis. Knowing the dividend growth rate is a key input for stock valuation models known as dividend discount models.
Key Takeaways
- Dividend growth calculates the annualized average rate of increase in the dividends paid by a company.
- Calculating the dividend growth rate is necessary for using a dividend discount model for valuing stocks.
- A history of strong dividend growth could mean future dividend growth is likely, which can signal long-term profitability.
What Is A Dividend?
Understanding the Dividend Growth Rate
Being able to calculate the dividend growth rate is necessary for using the dividend discount model. The dividend discount model is a type of security-pricing model. The dividend discount model assumes that the estimated future dividends—discounted by the excess of internal growth over the company's estimated dividend growth rate—determine a given stock's price.
If the dividend discount model procedure results in a higher number than the current price of a company’s shares, the model considers the stock undervalued. Investors who use the dividend discount model believe that by estimating the expected value of cash flow in the future, they can find the intrinsic value of aspecific stock.
A history of strong dividend growth could mean future dividend growth is likely, which can signal long-term profitability for a given company. When an investor calculates the dividend growth rate, they can use any interval of time they wish. They mayalso calculate the dividend growth rate using the least squares method or by simply taking a simple annualized figure over the time period.
How to Calculate the Dividend Growth Rate
An investor can calculate the dividend growth rate by taking an average, or geometrically for more precision. As an example of the linear method, consider the following.
A company's dividend payments to its shareholders over the last five years were:
- Year 1 = $1.00
- Year 2 = $1.05
- Year 3 = $1.07
- Year 4 = $1.11
- Year 5 = $1.15
To calculate the growth from one year to the next, use the following formula:
Dividend Growth= DividendYearX /(DividendYear(X - 1)) - 1
In the above example, the growth rates are:
- Year 1 Growth Rate = N/A
- Year 2 Growth Rate = $1.05 / $1.00 - 1 = 5%
- Year 3 Growth Rate = $1.07 / $1.05 - 1 = 1.9%
- Year 4 Growth Rate = $1.11 / $1.07 - 1 = 3.74%
- Year 5 Growth Rate = $1.15 / $1.11 - 1 = 3.6%
The average of these four annual growth rates is 3.56%. To confirm this is correct, use the following calculation:
$1 x (1 + 3.56%)4 = $1.15
Example: Dividend Growth and Stock Valuation
To value a company’s stock, an individual can use the dividend discount model (DDM). The dividend discount model is based on the idea that a stock is worth the sum of its future payments to shareholders, discounted back to the present day.
The simplest dividend discount model, known as the Gordon Growth Model (GGM)'s formula is:
P=r−gD1where:P=Currentstockpriceg=Constantgrowthrateexpectedfordividends,inperpetuityr=Constantcostofequitycapitalforthecompany(orrateofreturn)D1=Valueofnextyear’sdividends
In the above example, if we assumenext year's dividend will be $1.18 and the cost of equity capital is 8%, the stock's current price per share calculates as follows:
P = $1.18 / (8% - 3.56%) = $26.58.
What Is a Good Dividend Growth Rate?
A good dividend growth rate can be different for every investor. Generally, investors should seek out companies that have provided 10 years of consecutive annual dividend increases with a 10-year dividend per share compound annual growth rate (CAGR) of 5%.
What Is the Difference Between Dividend Yield and Dividend Growth?
Dividend yield is the amount that a company pays out in dividends compared to its stock price. Dividend growth is the increase in the value of dividends that a company pays out over a period of time.
Do Dividends Grow Every Year?
Whether or not dividends grow every year will depend on the company. Generally, well-established companies that pay dividends will ensure that dividends grow every year; however, it is not guaranteed that dividends grow every year.
The Bottom Line
Dividends can be a great boon to investor portfolios, providing a regular stream of income, which can be particularly beneficial when a stock hasn't witnessed much appreciation. Understanding how a company views its dividend payments and how the dividend's growth has been, can help investors make wise investment decisions. Utilizing the dividend growth rate calculation can help with these investment decisions.
FAQs
This formula calculates the growth rate as a percentage. Imagine a company paid a dividend of $1.00 per share last year and this year, it paid $1.10 per share. Here's how you'd plug those numbers into the formula: DGR = (1.10 - 1.00) / (1.00) X 100 = 10%
How to calculate a dividend growth rate? ›
Dividend growth formula
Arithmetic mean method formula: Where D2 equals the company's dividend for a specific period and D1 equals the company's dividends for a period before D2. DGR = [(Recent dividend (D2) - Previous dividend (D1)) x 100] / Previous dividend.
How do you calculate the dividend rate? ›
The formula for calculating the dividend yield is equal to the dividend per share (DPS) divided by the current share price. For example, if a company is trading at $10.00 in the market and issues annual dividend per share (DPS) of $1.00, the company's dividend yield is equal to 10%.
How is dividend calculated with example? ›
Using the Dividend Per Share (DPS) formula, we get: DPS = Dividend / Number of shares = ₹20 lakh / 5.5 lakh shares = ₹3.64 per share.
What is the meaning of dividend growth model formula? ›
The DGM formula is: P = D ( k − g ) (D) is the expected annual dividend per share for the next year, (k) is the required rate of return, and (g) is the dividend's expected growth rate. The sustainable growth rate is the rate at which a company can be expected to grow without any changes in debt or equity.
What does 10 year dividend growth rate mean? ›
Dividend Growth 10yr is the geometric average dividend growth rate over the past 10 years, shown as a percentage, for example 3.32%.
What is a good 5 year dividend growth rate? ›
To increase the likelihood that dividends will continue to grow in the future, analysts expect earnings to grow by at least 8% per year over the next five years and, except for one stock, at least 8% in the current year.
What is the formula for the rate of dividend? ›
Dividend Rate Formula
On a per-share basis, the dividend rate is the amount of annual dividend per stock, divided by the current price of the stock.
What is a good dividend rate? ›
What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.
What is the dividend formula calculator? ›
Here is the formula for calculating dividends: Annual net income minus net change in retained earnings = dividends paid.
A dividend yield is one of the ways investors determine if a stock is profitable. To find it, divide the stock's annual dividend by its current share price. So, if a stock is trading at $100 and its annual dividend per share is $5, the dividend yield is 5%.
What is a simple example of dividend? ›
What Is an Example of a Dividend? If a company's board of directors decides to issue an annual 5% dividend per share, and the company's shares are worth $100, the dividend is $5. If the dividends are issued every quarter, each distribution is $1.25.
What is the difference between yield and dividend rate? ›
While dividend yield refers to the percentage of the current stock price of a company paid out as dividend over a year, dividend rate is the amount of money that company pays to its shareholders as dividends on per-share basis.
How do you calculate dividend growth rate? ›
There are a few different methods for calculating dividend growth rates, including using MarketBeat's dividend calculator. The simplest way to do it is to take the current dividend per share and divide it by the dividend per share from the previous period. This will give you the dividend growth rate for that period.
What is the dividend growth model for dummies? ›
The model forecasts future dividends based on the current amount and a growth rate, then discounts each dividend back to the present day. The sum total is an estimate of the stock's value. The future dividends are discounted back to the present to determine their present value.
How does dividend growth work? ›
Dividend growth investing is a popular strategy with many investors. It entails buying shares in companies with a record of paying regular and increasing dividends. An added component is using the payouts to reinvest in the company's shares—or shares of other companies with similar dividend track records.
How to calculate growth rate? ›
To calculate the percentage growth rate, use the basic growth rate formula: subtract the original from the new value and divide the results by the original value. To turn that into a percent increase, multiply the results by 100.
What is the formula for stock growth rate? ›
Stock Growth Rate Formula
Stock growth can be measured by its absolute return, the difference between the starting and ending stock prices, or by its percentage return, calculated by dividing the absolute return by the initial price.
What is the formula for dividend gains? ›
Dividend Yield = Dividend per share / Market value per share
Where: Dividend per share is the company's total annual dividend payment, divided by the total number of shares outstanding. Market value per share is the current share price of the company.
