Dividend Growth Rate

Posted on by user

Dividend Growth Rate

The dividend growth rate is the annualized percentage change in a company’s dividend payments over time. It helps investors assess a firm’s financial health, estimate future income, and value stocks using dividend-based models like the dividend discount model (DDM). Historical dividend growth is often used as a proxy for future dividend potential and long-term profitability.

Key takeaways

  • Dividend growth rate measures how dividends per share increase year over year.
  • It’s a central input for dividend valuation models (e.g., Gordon Growth Model).
  • You can calculate it using simple year-to-year averages, geometric/CAGR, or statistical methods (least squares).
  • Consistent dividend growth is a positive signal, but not guaranteed to continue.

How to calculate dividend growth rate

There are several ways to calculate dividend growth. Two common approaches:

  1. Arithmetic (annual) growth rates
    For each interval: Growth = (Dividend in Year t / Dividend in Year t-1) − 1.
    Then average the annual growth rates.

  2. Geometric growth (CAGR) — preferred for multi-year growth
    CAGR = (Dividend_end / Dividend_start)^(1 / number_of_periods) − 1

Example:
A company’s dividends over five years:
* Year 1 = $1.00
Year 2 = $1.05
 Year 3 = $1.07
Year 4 = $1.11
 Year 5 = $1.15

Year-to-year growth rates:
* Year 2: 5.00%
Year 3: 1.90%
 Year 4: 3.74%
* Year 5: 3.60%

Arithmetic average = (5.00% + 1.90% + 3.74% + 3.60%) / 4 = 3.56%
CAGR = (1.15 / 1.00)^(1/4) − 1 = 3.56%

Both approaches can yield similar results for steady growth; CAGR is generally better for summarizing long-term growth.

Using dividend growth in valuation

The Gordon Growth Model (a simple DDM) values a stock as the present value of perpetually growing dividends:

P = D1 / (r − g)

Where:
* P = intrinsic stock price
D1 = next year’s dividend
 r = required rate of return (cost of equity)
* g = constant dividend growth rate (perpetuity)

Example:
If D1 = $1.18, r = 8% and g = 3.56%,
P = $1.18 / (0.08 − 0.0356) ≈ $26.58

Note: The model assumes dividends grow at a constant rate forever and that r > g. Small changes in g or r significantly affect the result.

Practical considerations and limits

  • Time period: Choose a horizon that reflects the company’s maturity and business cycle. Long histories smooth volatility but may include structural changes.
  • Method choice: Use CAGR for long-term trends; arithmetic averages can overstate expected future growth when rates vary. Regression or least-squares methods can reduce noise.
  • Sustainability: Check payout ratio, free cash flow, earnings stability, and industry dynamics. Rapid dividend growth may be unsustainable.
  • Company stage: Mature companies tend to have steadier, smaller dividend growth; high-growth firms may reinvest earnings instead of paying large dividends.

What is a “good” dividend growth rate?

There’s no universal cutoff. As a guideline, many investors favor companies that:
* Have 10+ consecutive years of dividend increases, and
* Deliver a 10-year dividend-per-share CAGR around 5% or higher

Higher growth rates can be attractive but should be vetted for sustainability.

Dividend yield vs. dividend growth

  • Dividend yield = annual dividend per share / current stock price (income today).
  • Dividend growth = change in dividends per share over time (future income trajectory).
    Both metrics matter: yield determines near-term income, growth determines how that income may increase.

Do dividends grow every year?

No. Dividend increases depend on a company’s profitability, cash flow, payout policy and economic conditions. Many established dividend-paying companies aim for consistent increases, but cuts or freezes can occur—especially during downturns.

Bottom line

The dividend growth rate is a useful measure for judging a company’s dividend trajectory and for valuing dividend-paying stocks. Use an appropriate calculation method (CAGR for long-term trends), verify growth’s sustainability, and combine dividend growth analysis with other financial metrics before making investment decisions.