Dividend Growth Rate

Loading the player...

What is the 'Dividend Growth Rate'

The dividend growth rate is the annualized percentage rate of growth that a particular stock's dividend undergoes over a period of time. The time period included in the analysis can be of any interval desired, and is calculated by using the least squares method or by simply taking a simple annualized figure over the time period.

BREAKING DOWN 'Dividend Growth Rate'

The dividend growth rate is necessary for using the dividend discount model, which is a security pricing model that assumes a stock's price is determined by the estimated future dividends, discounted by the excess of internal growth over the company's estimated dividend growth rate. A history of strong dividend growth could mean future dividend growth is likely, which can signal long-term profitability for a given company.

Calculation Example

The dividend growth rate can be calculated linearly by taking an average or geometrically for more precision. As an example of the linear method, consider the following.

A company's dividend payments to its shareholders over the last five years were:

Year 1 = $1.00

Year 2 = $1.05

Year 3 = $1.07

Year 4 = $1.11

Year 5 = $1.15

To calculate the growth from one year to the next, the following formula is used:

Dividend Growth = Year X Dividend / (Year X - 1 Dividend) - 1

In the above example, 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 confirm this is correct, the following calculation can be used:

$1 x (1 + 3.56%) ^ 4 = $1.15

Growth Rate Used in Dividend Discount Model

The dividend discount model is used to value a company's stock based on the idea a stock is worth the sum of its future payments to shareholders, discounted back to the present day. The formula takes into account three variable to arrive at a current price, P. They are:

D1 = the value of next year's dividend

r = the cost of equity capital

g = the dividend growth rate

The dividend discount model's formula is:

P = D1 / (r - g)

In the above example, if it is assumed next year's dividend will be $1.18 and the cost of equity capital is 8%, the stock's current price per share is:

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

RELATED TERMS
  1. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based ...
  4. Dividend Rate

    The total expected dividend payments from an investment, fund ...
  5. Dividend Discount Model - DDM

    A procedure for valuing the price of a stock by using predicted ...
  6. Supernormal Dividend Growth

    A period of time in which the dividends issued on shares of a ...
Related Articles
  1. Investing

    Understanding the Supernormal Growth Model

    The supernormal growth model values a stock that’s expected to have higher than normal growth in dividend payments for some period in the future.
  2. Investing

    Digging Into The Dividend Discount Model

    The DDM is one of the most foundational of financial theories, but it's only as good as its assumptions.
  3. Investing

    Valuing A Stock With Supernormal Dividend Growth Rates

    If these calculations are off, it could drastically change the value of the shares.
  4. Investing

    Why Dividends Matter

    Seven words that are music to investors' ears? "The dividend check is in the mail."
  5. Investing

    How Dividends Work For Investors

    Find out how a company can put its profits directly into your hands.
  6. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  7. Investing

    Microsoft Is Paying Dividends. Is Its Share Price Undervalued Or Overvalued Based On DDM? (MSFT)

    How can you use the dividend discount model to estimate the value the common stock of Microsoft?
  8. Managing Wealth

    The Risks of Chasing High Dividend Stocks

    Dividend stocks offer enticing yields, but a lot can go wrong on the way to collecting that dividend payout.
  9. Markets

    Using the Dividend Discount Model

    The dividend discount model is a way of applying net present value analysis to estimate the future dividends a stock will pay. Those dividends are then discounted back to their present value. ...
  10. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
RELATED FAQS
  1. How do I find the information needed for input into the Dividend Discount Model (DDM)?

    Learn where analysts and investors can find the three pieces of necessary information that allow them to calculate the dividend ... Read Answer >>
  2. How can I use the Dividend Discount Model (DDM) effectively for a stock with fluctuating ...

    Find out how the dividend discount model is applied to stocks with irregular dividend payments and how firms with irregular ... Read Answer >>
  3. What is the difference between yield and dividend?

    Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >>
  4. Can dividends be paid out monthly?

    Find out if stocks can pay dividends monthly, and learn about the types of companies most likely to do so and how monthly ... Read Answer >>
  5. What does the Dividend Discount Model (DDM) show an investor about a company?

    Discover the purpose of the dividend discount model, or DDM, of stock analysis and what it specifically aims to evaluate ... Read Answer >>
  6. What types of companies offer the most dividends?

    Find out which types of companies tend to offer the most dividends, and learn why dividends must be considered carefully ... Read Answer >>
Hot Definitions
  1. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  2. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  3. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  4. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  5. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  6. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
Trading Center