What is Dividend Growth?
Dividend Growth is the substantial increase in the dividend payout by a company to its shareholders from one period of time to another period of time with comparison to the dividend payout of the previous period of time taken (generally the growth is calculated on yearly basis).
In simpler terms, if the dividend distributed by a company to its shareholder increases over a substantial period of time, then this rate gives out the percentage increase in the dividend payout by the company over the upcoming period of time comparing to the previous period. The dividend that the company pays to its shareholders is the apportion of its profits attributable for the respective period, thus the dividend growth is also a way for the analyzer to determine the performance of the company throughout the period.
Dividend Growth Formula
- Dividend(D1) = Dividend paid by the company for the Period P (any period)
- Dividend(D2) = Dividend paid by the company for the Period P-1 (period before period P)
- (This formula is beneficial to use in the case where the D1 & D2 are dividends payed out at adjacent time period)
In case the compound rate is to be calculated on the basis of dividends available for periods where they are not adjacent periods i.e., the difference between the period is more than 1, Then following formula is used to calculate this;
- Dividend(Dn) = Dividend for the period n
- Dividend(D0) = Dividend for the starting period or initial period
- N = The difference between the period Dn & Do
How to Calculate? (Step by Step Explanation)
- The user first needs to collect the data of the Dividend payout history of the securities.
- In case the dividend payout for two adjacent periods are available and the growth is to be calculated for two adjacent periods, categories the dividend paid in the previous period as ‘D1’ & in the next period as ‘D2’.
- Put the value in the provided formula and the growth will be found as a result.
- In case the compounded growth rate is to be calculated based on the data of two periods who are not adjacent then collect the data and categories the initial dividend paid as ‘Do’ & next dividend as ‘Dn’ & calculate the difference between the two periods which will be termed as ‘n’.
- Put the same values in the compounded growth rate formula for the evaluation of the rate.
ABC Ltd is a listed company on the Indian Stock Exchange. The current share price of a company is Rs. 150. The company has paid a dividend of Rs. 5 per share in the previous year, this year company has decided to pay the dividend of Rs. 5.50 per share. Comment on the dividend growth rate of the company.
- Dividend(D2) = Rs. 5.50 per share
- Dividend(D1) = Rs. 5.00 per share
Now putting these values in the formula we will get,
Dividend Growth vs High Yield
- High yield is the rate calculated by comparing the amount of money the company is paying to its shareholders against the market value of the security in which the investment is done by the shareholders. Dividend high yield is calculated with dividend amount and stock price. To calculate the dividend yield, the dividend amount is divided by the current share price.
- Dividend growth is calculated by considering factors like annual growth, cost of equity or rate of return and dividend amount pays by the company. It calculates the share price of the company and compares that price with the current market price of a share. By this, it evaluates whether the share is overvalued or undervalued. Accordingly, the investor can make the decision of whether to invest in that stock or not.
- In dividend high yield, the yield will increase if the stock price of the company will decrease or the dividend payout rate is increased. In short-run investors can invest for high yield but in the long run, an investor needs to analyze yield as well as growth.
- The increment in the dividend payout by the company in the years results in the dividend growth & this results in the rate at which such growth is incurring.
- The dividend paid by the company for the securities is the appropriation done from the profit of the company for that period. Hence if a company is showing a healthy increase in the dividend then it shows that the companies finances are getting strong and the company is recording more profits in the upcoming periods.
- This becomes the key point for the investors to consider before investing as the investors will be expecting to receive good dividends against their investments. And this increase in the growth rate may also result in an increase in the market value of the securities of the company if the company is earning healthy market returns.
- This model works on a few assumptions. One assumption in this model is that it is assumed that dividends will grow at a constant rate. There are only a few chances of constant growth because it depends on business growth or business cycle. Businesses can face unexpected difficulties or successes. This model has its limitation that it is only applicable to those companies that have a stable growth rate.
- Second is If growth rate and rate of return or cost of equity are the same then this formula is worthless because in this case share price reaches infinity. And in case the growth rate is higher than the rate of return (cost of equity) then it will calculate share price negatively, so in a few cases, this model becomes worthless.
- Investor’s lookout for dividend growth trends before deciding to invest their funds as they are expecting more yield for their investments. The increased growth rate sometimes become trouble for the company as their might come to a situation where the most of the surplus earned by the company during the period may have been thought up to be used in some business growth processes but due to the market trend and the investors’ expectations the company might have to sacrifice some portions for paying the expected dividend.
This has been a guide to What is Dividend Growth & its Definition. Here we discuss how to calculate the dividend growth rate using formula along with examples, advantages, and disadvantages. You can learn more about from the following articles –