Dividend Growth Rate (DGR): Definition & Calculation

The dividend growth rate (DGR) is the percentage growth rate of a company’s dividendDividendA dividend is a share of profits and retained earnings that a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend. achieved during a certain period of time. Frequently, the DGR is calculated on an annual basis. However, if necessary, it can also be calculated on a quarterly or monthly basis.

The dividend growth rate is an important metric, particularly in determining a company’s long-term profitability. Since dividends are distributed from the company’s earningsRetained EarningsThe Retained Earnings formula represents all accumulated net income netted by all dividends paid to shareholders. Retained Earnings are part, one can assess and analyze its ability to sustain its profitability by comparing the DGR over time.

Dividend Growth Rate and a Security’s Pricing

Also, the dividend growth rate can be used in a security’s pricing. It is an essential variable in the Dividend Discount Model (DDM).

The dividend discount model is based on the idea that the company’s current stock price is equal to the net present valueNet Present Value (NPV)Net Present Value (NPV) is the value of all future cash flows (positive and negative) over the entire life of an investment discounted to the present. of the company’s future dividends. Mathematically, the dividend discount model is written using the following equation:

Where:

• P₀ – the current company’s stock price
• D₁ – the next year dividends
• r – the company’s cost of equity
• g – the dividend growth rate

How to Calculate the Dividend Growth Rate

The simplest way to calculate the DGR is to find the growth rates for the distributed dividends.

Let’s say that ABC Corp. paid its shareholders dividends of $1.20 in year one and $1.70 in year two. To determine the dividend’s growth rate from year one to year two, we will use the following formula:

However, in some cases, such as in determining the dividend growth rate in the dividend discount model, we need to come up with the forward-looking growth rate.

Prior to studying the approaches, let’s consider the following example. Below is ABC Corp.’s schedule of paid dividends with the calculated annual DGR:

There are three main approaches to calculate the forward-looking growth rate:

1. Use historical dividend growth rates.

a. Using the historical DGR, we can calculate the arithmetic average of the rates:

b. We can also use the company’s historical DGR to calculate the compound annual growth rate (CAGR):

2. Observe the dividend growth rate prevalent in the industry in which the company operates.

Imagine that the average DGR in the industry in which the ABC Corp. is operating is 4%. Then, we can use that rate for ABC Corp.

3. Calculate the sustainable growth rate.

The sustainable growth rate is the maximum growth rate that a company can sustain without external financing. The sustainable growth rate can be found using the following formula:

If ABC Corp.’s ROEReturn on Equity (ROE)Return on Equity (ROE) is a measure of a company’s profitability that takes a company’s annual return (net income) divided by the value of its total shareholders' equity (i.e. 12%). ROE combines the income statement and the balance sheet as the net income or profit is compared to the shareholders’ equity. is 15% and its dividend payout ratio is 65%, then the company’s sustainable growth rate will be:

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• CAGR CalculatorCAGR CalculatorThis CAGR calculator will help you determine the Compound Annual Growth rate of an investment. CAGR is a great measure of growth, as it isolated the effect of compounding on growth, which is sometimes concealed on other metrics for growth. CAGR stands for compound annual growth rate.
• Capital Gains YieldCapital Gains YieldCapital gains yield (CGY) is the price appreciation on an investment or a security expressed as a percentage. Because the calculation of Capital Gain Yield involves the market price of a security over time, it can be used to analyze the fluctuation in the market price of a security. See calculation and example
• Ex-Dividend DateEx-Dividend DateThe ex-dividend date is an investment term that determines which stockholders are eligible to receive declared dividends. When a company announces a dividend, the board of directors set a record date when only shareholders recorded on the company’s books as of that date are entitled to receive the dividends.
• Return on Total CapitalReturn on Total CapitalReturn on Total Capital (ROTC) is a return on investment ratio that quantifies how much return a company has generated through the use of its capital structure. This ratio is different from return on common equity (ROCE), as the former quantifies the return a company has made on its common equity investment.