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Dividend Growth

Updated on April 30, 2024
Article byWallstreetmojo Team
Edited byPallabi Banerjee
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Dividend Growth?

Dividend Growth is the substantial increase in the dividend payout by a company to its shareholders from one period to another compared to the dividend payout of the previous period taken (generally, the growth is calculated every year).

Dividend Growth

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Investors look out for dividend growth trends before deciding to invest their funds as they are expecting more yield for their investments. The increased growth rate sometimes becomes a problem for the company. A company might come to a situation where most of its surplus during a period may have been thought up to be used in some business growth processes. However, due to the market trend and the investors’ expectations, it might have to sacrifice some portions to pay the expected dividend.

Key Takeaways

  • . Dividend growth refers to the significant increase in a company’s dividend payout to its shareholders from one period to another, typically annually. This growth is measured relative to the dividend payout of the previous period.
  • One may analyze dividend growth using annual growth rate, equity cost, return rate, and dividend amount. It helps us determine if a share is overpriced or undervalued, helping investors make informed decisions about buying stock.
  • Shareholders consider dividend growth before investing, but it can strain a company’s surplus if they prioritize payouts over business growth.

Dividend Growth Explained

Dividend growth is the rise in the amount of dividend over time that is paid to the investors. When a company is able to earn good revenue and generate profits, it usually distributes it to its shareholders in the form of dividend.

In simpler terms, if the dividend distributed by a company to its shareholder increases over a substantial period, this rate gives out the percentage increase in the dividend payout over the upcoming period compared to the previous period. The company’s dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more to its shareholders is the apportion of its profits attributable to the respective period. Thus, dividend growth investing is also a way for the analyzer to determine the company’s performance.

Some companies give a lot of priority to its dividend payment resulting in a good track record and an investor trust that the business is able to sustain its profitability over the years. It is good for investors who are seeking regular income for long term wealth accumulation. It also signals that the business is have a sound financial policy

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Formula

Dividend Growth formula

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Given below are the various formula used in the calculation of the growth of dividend in the dividend growth stocks.

Dividend Growth Formula = Dividend(D2) – Dividend(D1) * 100 / Dividend(D1)

Where,

  • 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 (the period before period P)
  • (This formula is beneficial to use in the case where the D1 & D2 are dividends paid out at an adjacent period)

In case the compound rate is to be calculated based on dividends available for periods where they are not adjacent. I.e., if the difference between the period is more than 1, and then the following formula is used to calculate dividend in the dividend growth stocks:

Dividend Growth = (Dividend(Dn) / Dividend(Do))1/n – 1

Where,

  • 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?

The steps used to make the calculation of the growth in dividend are provided in details. Let us try to understand them.

  1. The user first needs to collect the data on the Dividend payoutDividend PayoutThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company's net income. Formula = Dividends/Net Incomeread more history of the securities.
  2. In case the dividend payout for two adjacent periods is available, to calculate the growth for two adjacent periods, categorize the dividend paid in the previous period as ‘D1’ & in the next period as ‘D2’.
  3. Put the value in the provided formula, and you can find the growth.
  4. To calculate compounded growth rate based on data of two periods, which are not adjacent, collect the data and categorize the initial dividend paid as ‘Do’ & next dividend as ‘Dn.’ Calculate the difference between the two periods, which term it as ‘n.’
  5. Put the same values in the compounded growth rate formula to evaluate the rate.

Examples

A suitable example will help us to understand the topic of dividend growth model clearly.

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 the company has decided to pay a dividend of Rs. 5.50 per share. Comment on the dividend growth rateDividend Growth RateDividend Growth Rate is the rate of growth of a stock's dividend on a year-to-year basis (in percent). It varies according to business cycles and can be addressed monthly or quarterly.read more of the company.

Solution-

  • Dividend(D2) = Rs. 5.50 per share
  • Dividend(D1) = Rs. 5.00 per share

Now putting these values in the formula, we will get,

Examples of Dividend Growth

Advanatages

Like every financial concept has its own advantage and disadvantage, so does this concept of dividend growth investing. Let us first identify the advantages of the same.

  • Increment in dividend payout by the company in the years results in dividend growth & provides the rate at which such growth is incurring.
  • The dividend paid by the company for securities is the appropriation from the company’s profit for that period. Hence, if a company is showing a healthy dividend increase, it shows that the company’s finances are getting healthy, and the company is recording more profits in the upcoming periods.
  • It becomes a critical 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 increase the market value of the company’s securities if the company is earning healthy market returns.

Disadvantages

Now let us identify the disadvantages of the same.

  • This dividend growth model works on a few assumptions. One assumption in this model is that it assumes that dividends will grow at a constant rate. There are only a few chances of continuous growth because it depends on business growth or business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline.read more. Businesses can face unexpected difficulties or successes. This model has its limitation: it only applies to companies with a stable growth rate.
  • Second, if the growth rate and rate of return or cost of equity are the same, this formula is worthless because, in this case, the 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 dividend growth model becomes worthless.
  • A company may be able to pay steady dividend but there may be changes in the company policies and rules regarding dividend payment. They may reduce the amount due to investment and expansion requirements or economic downturns. However, it does not prove that the company is facing losses or is in a weak financial condition. Thus, dividend growth is not always a true measure of business performance.
  • All investors may not have dividend as a priority. Investors should understand their own investment goals and selects companies according to their own expectations and in alignment with their financial needs.

Thus, we see that it is necessary to understand both the positive and negative sides of any financial concept to that investors can select companies as per their own risk tolerance, financial goals, time horizon and proper company analysis.

Dividend Growth Vs Dividend Yield

Both the above financial concepts are very commonly used in the financial market. However, it is necessary to understand the differences between them, as follows.

  1. Dividend yield is the rate calculated by comparing the amount of money the company is paying its shareholders against the market value of the security in which the shareholders invest. We require a dividend amount and stock price to calculate a high dividend yield. To calculate the dividend yieldCalculate The Dividend YieldDividend Yield is calculated by dividing annual dividend per share by current market price of the share. It is one of the most important metrics in deciding whether an investment into the share will result in the expected returns.read more, divide the dividend amount by the current share price.
  2. To calculate dividend growth rate, we consider factors like annual growth, cost of equityCost Of EquityCost of equity is the percentage of returns payable by the company to its equity shareholders on their holdings. It is a parameter for the investors to decide whether an investment is rewarding or not; else, they may shift to other opportunities with higher returns.read more, rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more, and dividend amount paid by the company. It calculates the company’s share price 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 decide whether to invest in that stock or not.
  3. In a high dividend yield, the yield will increase if the company’s stock price decreases or if the dividend payout rate increases. In the short run, investors can invest for a high yieldInvestors Can Invest For A High YieldHigh yield investments refer to those financial instruments that offer impressive returns to the investors but involve a great deal of credit risk. These are usually fixed income instruments issued by highly leveraged or small scale companies.read more, but in the long run, an investor needs to analyze yield and dividend growth rate.

Frequently Asked Questions (FAQs)

Why is dividend growth vital?

A company’s ability to generate cash flow and maintain strong financial standing might be indicated by its dividend growth. Companies with a history of increasing dividends may be less risky than other investments because of this, which can increase stock values.

What is dividend growth vs growth?

In a growth strategy, the extra profit made on the stock is put back into it. In contrast, investors receive consistent returns via dividends at regular intervals and gains from growth investments. The risk that such investors take on is higher since the profits on such investments are higher.

Does the dividend growth rate affect stock price?

The stock price often rises after the declaration of a stock dividend, but because a stock dividend raises the number of shares outstanding. At the same time, the company’s value stays the same, it dilutes the book value per common share, and the stock price falls.

Recommended Articles

This has been a guide to what is Dividend Growth. We explain its formula, how to calculate, its differences with dividend yield, with example & advantages. You can learn more about it from the following articles –

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