Dividend Growth

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).

Explanation

In simpler terms, if the dividend distributed by a company to its shareholder increases over a substantial period, then this rate gives out the percentage increase in the dividend payout over the upcoming period comparing to the previous period. The dividend that the company pays to its shareholders is the apportion of its profits attributable to the respective period. Thus the dividend growth is also a way for the analyzer to determine the performance of the company.

Dividend Growth

Dividend Growth Formula

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 adjacent period)

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

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? (Step by Step Explanation)

  1. The user first needs to collect the data of the Dividend payout history of the securities.
  2. In case the dividend payout for two adjacent periods are available, to calculate the growth for two adjacent periods, categories 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 as a result.
  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 for the evaluation of the rate.

Examples

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.

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

Dividend Growth vs. High Yield

  1. 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 shareholders invest. To calculate Dividend high yield, we require a dividend amount and stock price. To calculate the dividend yield, divide the dividend amount by the current share price.
  2. To calculate Dividend growth, we consider factors like annual growth, cost of equity, or rate of return, and dividend amount paid 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 decide whether to invest in that stock or not.
  3. In high dividend yield, the yield will increase if the stock price of the company will decrease, or if the dividend payout rate increases. In short-run investors can invest for high yield, but in the long run, an investor needs to analyze yield as well as growth.

Benefits

  • 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 done, from the company’s profit, for that period. Hence if a company is showing a healthy increase in the dividend, then it shows that the companies finances are getting healthy, and the company is recording more profits in the upcoming periods.
  • It becomes the 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 securities of the company if the company is earning healthy market returns.

Disadvantages

  • This 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 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.

Conclusion

  • 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 trouble for the company. A company might come to a situation where most of the surplus earned by it 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 for paying the expected dividend.

Recommended Articles

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 –

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