Before starting to make investments in stock markets, you must make an effort to understand the vital indicators of stocks. One such key indicator or measure of stocks is the dividend growth rate. Publicly listed companies pay dividends to its shareholders in various forms, including cash. The dividends are paid out of the net profits of a company. Calculating the dividend growth rate in stock markets could help you calculate the long-term returns from your investments in various stocks, and thus aid in making informed decisions.
Understanding dividend growth rate
The dividend growth rate is the percentage of growth of a particular company’s stocks over a period of time. Typically, this rate is calculated on an annual basis, considering the fact that companies increase their dividend payouts to shareholders, over a number of years. You can also calculate the dividend growth rate in stock markets on a quarterly, half-yearly or monthly basis, if required.
Dividend growth rate and stock valuation models :
To know the value of stocks, valuation models such as the dividend discount model are used. This model of stock valuation takes into account factors such as the company’s net present value to estimate the intrinsic value of its stocks. According to the dividend discount model, you have to deduct the excess of the company’s internal growth rate (the maximum growth rate which is possible for a company without obtaining external finance) from the estimated dividend growth rate to know the price of a particular stock. If any stock’s current price is lower than the price calculated via this model, then as per the model, the price of the stock is undervalued. The mathematical formula for the dividend discount model is : P0 = D1/r-g, where Po is the company’s current stock price, D1 being the next year’s dividends and r and g implying the company’s cost of equity and the dividend growth rate respectively.
How to calculate dividend growth rate in stock markets?
You can calculate dividend growth rate by using either the arithmetic mean or via the compounded method calculation.
Dividend growth rate formula using arithmetic mean :
In this method, you can arrive at the dividend growth rate by the using the steps given below:
- Step 1: You are required to find the information regarding dividend payments over a period of time. You can find the relevant date in the annual reports of a particular company. To determine the dividend growth rate you can use the mathematical formula G1= D2/D1-1, where G1 is the periodic dividend growth, D2 is the dividend payment in the second year and D1 is the previous year’s dividend payout. If XYZ company has made Rs 10,000 annual dividend payment in 2010, along with Rs 10,500 dividend payment in 2011, the dividend growth rate will be: 10,500/10,000-1= 0.05 or 5%. Similarly, over a period of time the dividend growth rates of XYZ company will be as per the chart given below:
|Year||Dividend||Dividend growth rate|
- Step 2: Now determine the number of years for which the periodic dividend growth rates have been provided. The dividend growth rate formula using arithmetic mean denotes this number as ‘n.’ For instance, in the above-mentioned chart, n=4 years.
- Step 3: Now you are required to use the mathematical formula: Dividend growth rate = (G1+G2+G3……+Gn)/ n. So, as per the above mentioned chart the arithmetic average will be 5%+9.52%+1.74%+6.84%/4= 5.78%.
- Dividend growth rate formula using compounded method calculation : Along with the arithmetic mean method, you can also use the Compound Annual Growth Rate (CAGR) formula to know about the dividend growth rate in stock markets. You have to follow the steps given below:
- Step 1: Foremost, you are required to find the initial dividend payment from the annual report of a company. The dividend growth rate formula using the compounded method denotes the initial dividend payment period as D0. Next, determine the recent or final dividend payment period. This is denoted by Dn.
- Step 2: You now need to calculate the number of years, beginning from the initial dividend payment year and the final dividend payment year. The CAGR method denotes this variable by n.
- Step 3: Now you can calculate the compounded annual dividend growth rate by dividing the final dividend with the initial dividend and placing the calculated variable to the power of reciprocal of the number of periods. Now subtract one from it to arrive at the final figure. Mathematically, this dividend growth rate formula can be expressed as : Dividend growth rate= (Dn/D0)1/n-1.
Let us understand the calculation with the help of an example. Suppose for ABC company, the dividend payments are:
|Year||Annual dividend||Dividend growth rate|
By using the above-mentioned dividend growth rate formula , the calculation will be : (27,200/18,200) ¼-1)*100= 10.57%. Thus, the annualised dividend growth rate, as per the compounded growth method for company ABC will be 10.57%.
Benefits of assessing dividend growth rates in stock markets
Calculating the dividend growth rate in stock markets can provide the following benefits to individual investors:
Assessment of earnings from stocks :
This concept can help you to assess how much you can possibly earn from a particular company’s stock. If the company has strong dividend growth figures over a number of years, it could mean a similar dividend growth in future. This, in turn, would imply long-term profitability from your investment.
Determining the intrinsic value of stocks :
Once you know the dividend growth rate, you can easily determine the intrinsic value of stocks as compared to its current market value by using the dividend discount model of stock valuation.
Freedom to calculate dividend growth rate for any time period :
Apart from annual dividend rate growth calculation, you can use the mathematical formulas to calculate the growth rate for any intervals.
Thus, it is imperative for any investor to understand the concept of dividend growth rate in stock markets. Along with knowing the key concepts of stock market trading, you should also select a trusted and reliable financial partner. A stockbroking company with proven credentials can provide you with multiple benefits, like free Demat and trading accounts, free equity delivery trade for lifetime, single point access to all markets, in-depth research reports and personalised customer support.