Dividend growth rate is a crucial metric for investors who seek to invest in dividend-paying companies with a sustained track record of growing dividend payments over time. Calculating the dividend growth rate will help you determine the attractiveness of a particular stock based on the company’s ability to increase its dividends consistently. In this article, we will explain how to calculate the dividend growth rate using various methods.

1. Constant Dividend Growth Rate Model (Gordon Growth Model):

The Gordon Growth Model, also known as the Dividend Discount Model (DDM), helps investors estimate the value of a stock by incorporating the dividends’ projected growth rate. The formula for calculating constant dividend growth rate using this model is:

Dividend Growth Rate (g) = (Next Year’s Expected Dividends per Share – Current Year’s Dividends per Share)/(Current Year’s Dividends per Share) x 100%

For example, if a company’s current year’s dividends per share are $2, and next year’s expected dividends per share are $2.20:

Dividend Growth Rate (g) = ($2.20 – $2)/($2) x 100% = 10%

2. Historical Dividend Growth Rate:

Calculating the historical dividend growth rate requires data from previous years’ dividend payments. This method involves finding the Compound Annual Growth Rate (CAGR) of dividends over a specific period.

CAGR = (Ending Dividends per Share/Beginning Dividends per Share)^(1/n) – 1

Where “n” is the number of years between the beginning and ending periods.

For example, suppose a company paid dividends of $1 per share five years ago and currently pays a dividend of $1.50 per share. The historical dividend growth rate would be:

CAGR = ($1.50/$1)^(1/5) – 1 = 8.45%

3. Current Year’s Percentage Change:

Another method of calculating dividend growth rate is to compare the current year’s dividends per share with the previous year’s dividends per share. The formula is:

Dividend Growth Rate = (Current Year’s Dividends per Share – Previous Year’s Dividends per Share)/(Previous Year’s Dividends per Share) x 100%

For example, if a company paid a dividend of $1 per share last year and is paying $1.10 this year:

Dividend Growth Rate = ($1.10 – $1)/($1) x 100% = 10%

Conclusion:

Calculating the dividend growth rate helps investors gauge the potential of their investments in dividend-paying stocks and make informed decisions based on the company’s ability to maintain or increase its dividends over time. By using methods like the Gordon Growth Model, historical dividend growth rate, or the current year’s percentage change, investors can make better choices and build a strong, stable income-producing portfolio.