DEFINITION of Supernormal Dividend Growth
A supernormal dividend growth rate is a period of time in which the dividends issued on shares of stock are increasing at a higher than normal rate. The high growth rate of payouts are seen as above normal, thus "supernormal." Because this rate is also expected to be unsustainable, the dividend growth rate is expected to return to normal levels again. Supernormal dividend growth is a projected rate based on an analysis of a company and/or industry, which determines a period of increased earnings and thus potential payouts.
BREAKING DOWN Supernormal Dividend Growth
Stocks of these companies can be valued using a discounted cash flow model. Investors who purchase stocks based on dividend growth should know three general models:
- Dividend discount model with no growth in dividends.
- Dividend discount model with constant dividend growth.
- Dividend discount model with supernormal dividend growth.
Even though "growth" is used, you should think about the change in dividend payments; this may include varying discount rates. In this sense, periods of different rates of growth are discounted separately, then combined to get the total value. In these calculations, investors have to determine the required rate of return, the time periods, and rate of growth, all of which are difficult to predict and can drastically change the valuation of the stock.
For exciting new or innovative products and services, a supernormal growth rate is reasonable. For example, those businesses capable of seizing the potential of artificial intelligence should enjoy supernormal growth rates before these technologies become mainstream.
When using supernormal growth rates in dividend discount models, the model becomes rather sensitive to the growth rates used, as such, they can have an outsized influence on the ending values. Thus, users of these projections are cautioned to pay attention to the embedded assumptions.