Dividend Growth Rate

What Is Dividend Growth Rate?

The dividend growth rate is the annualized percentage rate of growth that a specific stock's dividend goes through throughout some stretch of time. Many mature companies try to increase the dividends paid to their investors consistently. Knowing the dividend growth rate is a key contribution for stock valuation models known as dividend discount models.

Understanding the Dividend Growth Rate

Having the option to compute the dividend growth rate is essential for utilizing 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-determines a given stock's price. In the event that the dividend discount model strategy brings about a higher number than the current price of a company's shares, the model considers the stock undervalued. Investors who utilize the dividend discount model trust that by assessing the expected value of cash flow from now on, they can track down the intrinsic value of a particular stock.

A history of strong dividend growth could mean future dividend growth is probable, which can signal long-term profitability for a given company. At the point when an investor computes the dividend growth rate, they can utilize any interval of time they wish. They may likewise work out the dividend growth rate utilizing the least squares method or by basically taking a simple annualized figure throughout the time span.

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Instructions to Calculate the Dividend Growth Rate

An investor can compute the dividend growth rate by taking an average, or mathematically for more precision. To act as an illustration of the linear method, think about the accompanying.

A company's dividend payments to its shareholders throughout the course of recent years were:

• Year 1 = $1.00
• Year 2 = $1.05
• Year 3 = $1.07
• Year 4 = $1.11
• Year 5 = $1.15

To compute the growth over time, utilize the accompanying formula:

Dividend Growth= Dividend_YearX/(Dividend_{Year(X - 1)}) - 1

In the above model, 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 affirm this is right, utilize the accompanying calculation:

$1 x (1 + 3.56%)⁴ = $1.15

Model: Dividend Growth and Stock Valuation

To value a company's stock, an individual can utilize the dividend discount model (DDM). The dividend discount model depends on the possibility that a stock is worth the sum of its future payments to shareholders, discounted back to the current day.

The simplest dividend discount model, known as the Gordon Growth Model (GGM's) formula is:
$\begin &P = \frac{ r - g } \ &\textbf \ &P = \text \ &g = \text \ &\text{dividends, in perpetuity} \ &r = \text \ &\text{company (or rate of return)} \ &D_1 = \text{Value of next year's dividends} \ \end$
In the above model, in the event that we assume next year's dividend will be $1.18 and the cost of equity capital is 8%, the stock's current price per share computes as follows:

P = $1.18/(8% - 3.56%) = $26.58.

Features

• A history of strong dividend growth could mean future dividend growth is possible, which can signal long-term profitability.
• Computing the dividend growth rate is vital for utilizing a dividend discount model for esteeming stocks.
• Dividend growth works out the annualized average rate of increase in the dividends paid by a company.