Calculate the Estimated Dividend Growth Rate for a Stock
As most investors know, mature companies tend to pay dividends, sending checks that represent a small fraction of the company’s profits to shareholders on a quarterly basis. While some investors prefer the volatility and excitement that often accompanies small-cap stock investing, the combination of capital gains through stock price appreciation along with income through dividends can be very attractive. Add to this the possibility of dividend growth and the case for investing in these more mature companies becomes quite compelling.
What is Dividend Growth Rate?
The dividend growth rate refers to the annual rate of growth that a stock offers over a period of time. A history of solid dividend growth can provide an indication that continued dividend growth is likely for that company into the future. As the dividend grows, shareholders can count on the stock price to rise because the more income it produces the more valuable the stock becomes- a scenario referred to as a “double dip”.
Watching the Dividend Payout Ratio
The dividend payout ratio is the proportion of company earnings that it allocates to paying dividends to shareholders. The ratio offers an indication as to how well company earnings support its dividend payments. In general, more mature companies offer higher payout ratios.
The formula for the dividend payout ratio can be written as:
Dividend Payout Ratio = Annual Dividend per Share / Earnings per Share
The key for shareholders is that, as long as the company maintains a constant dividend payout ratio as it grows, that payout ratio represents a continually growing amount.
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Estimating Dividend Growth Rates
It follows then that a company’s dividend growth rate can be estimated by projecting its earnings growth. In estimating the dividend growth rate, it is assumed that the return on equity and dividend payout ratio are held constant.
The formula to estimate the dividend growth rate can be written as:
Dividend Growth Rate = Plow Back Ratio x Return on Equity
The plow back ratio is simply (1- dividend payout ratio)
The Stock Research Pro Valuation Software
The SRP Valuation software offers three modules to assess the value of a stock and the health of a company:
• Discounted Cash Flow (DCF)
• Net Current Asset Value per Share (NCAVPS)
• Dividend Discount Model (DDM)
Each module includes a video tutorial to guide you through the process.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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