Dividends are additional bonuses offered by a company to its stock investors at regular intervals. These are a part of a company's profits that are offered to shareholders based on the number of shares they hold. Know that not all stocks offer dividends.
The dividend growth rate represents the annual growth rate of a dividend that the company offers. It talks about the annual average percentage rise in the dividend rate in a single year. Let’s say that you have invested in a company that promises you benefits through shares and dividends. Additionally, the company also offers the benefit of increased payouts after every year. This increase in payouts every year is represented by the dividend growth rate.
If you are interested in building long-term wealth then understanding the breakdown of dividend growth rate becomes crucial. Let’s explore the dividend growth rate and the mechanics behind it.
How to Calculate the Dividend Growth Rate?
Now that you have a fair understanding of what the dividend growth rate is, let's see how you can easily calculate the dividend growth rate. Remember that there are different ways of calculating the dividend growth rate, and you can rely on finding the growth rate for distributed dividends for a simple calculation.
Imagine that a particular company offers its shareholders dividends worth ₹1.20 in the first year and ₹1.70 in the next year. Now, to calculate the dividend growth rate from the first year to the second year, you can use the following formula:
Dividend Growth Rate = Dividend Paid in the Second Year/Dividend Paid in First Year - 1.
Therefore, the dividend growth rate for the above example would be ₹1.70/₹1.20-1 = 41.67%.
Or,
You can also use the following formula,
Year Over Year Growth Rate- Dividend Growth Rate (Dividend Growth Rate in Current Year/Dividend Growth in the Previous Year - 1) * 100.
Example of Dividend Growth Rate
Let’s take an example to understand the dividend growth rate better:
Imagine that a certain company has the following dividend payouts for succeeding years:
Year
| Dividend Per Share
|
2018
| ₹ 1.50
|
2019
| ₹ 1.65
|
2020
| ₹ 1.82
|
2021
| ₹ 2.00
|
Here, you can see that the company has increased its dividend payouts every year. Now, you can calculate the dividend growth rate of each year in the following way:
Dividend Growth Rate = (Dividend Growth Rate of current year/ Dividend Growth Rate of previous year -1) * 100.
For 2019, the dividend growth rate would be (1.65/1.50-1)* 100= 10%.
For 2020, the dividend growth rate would be (1.82/1.65-1) * 100= 10.3%
For 2021, the dividend growth rate would be (2.00/1.82-1)* 100= 9.89%.
Additionally Read - Dividend Yield Calculator
Growth Rate of Dividends and Its Impact on Security Pricing
Know that the dividend growth rate and security pricing are not mutually exclusive. This means that as the rate of dividends increases annually it impacts the value and pricing of security of the said company as well.
Let’s take a quick look at the impact of dividend growth rate on security pricing:
The Gordon Growth Model Impact
The Gordon Growth Model shows an evident impact of the dividend growth rate on security pricing, here’s how:
P= D1/ r-g.
Here, P is the stock price, r is the required rate of return or the discount rate, D1 is the expected dividend in the next year and g is the dividend growth rate.
Now, to understand the impact, remember that if the dividend growth rate is increasing, the denominator decreases thus leading to a growth in the stock price and if the dividend growth rate decreases there is a decline in the stock price.
Impact on the Market Sentiments
In addition to the technical relation between the dividend growth rate and stock pricing, there are certain market sentiments that you must be aware of. For instance, when a company announces a decline in its dividend growth, this often leads to investors selling their shares, which eventually results in a fall in the stock price. Additionally, when the dividend growth rate is higher it represents a promising financial health of the company that attracts long-term investors.
Conclusion
Investors often prioritise stocks that offer dividends as it helps expand a profit margin even when the benefits from the stock may not be showing promising results. Therefore understanding the way a company offers dividends and the factors that often lead to an increase in the dividend growth rate becomes crucial to creating a profitable investment portfolio.
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