What is Dividend Growth?

Explanation

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 is also a way for the analyzer to determine the company’s performance.

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

  • Dividend(Dn) = Dividend for the period nDividend(D0) = Dividend for the starting period or initial periodN = The difference between the period Dn & Do

How to Calculate? (Step by Step Explanation)

  • 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.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’.Put the value in the provided formula, and you can find the growth.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.’Put the same values in the compounded growth rate formula to evaluate 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 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 shareDividend(D1) = Rs. 5.00 per share

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

Dividend Growth vs. High Yield

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 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

  • 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 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 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 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.

This has been a guide to What is Dividend Growth & its Definition. Here we discuss calculating the dividend growth rate using a formula along with examples, advantages, and disadvantages. You can learn more about it from the following articles –

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