# Calculating Dividend Growth Rate: Definition, Formula, and Example

![Dividend Growth Rate](https://www.investopedia.com/thmb/0Q5mydbp1xbyxXg7tPaWMeqR0Sc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/dividendgrowthrate-final-b83e22b0413c454aa4083ec89f65c1b8.jpg)

*— Investopedia / Sydney Burns*

The dividend growth rate is the [annualized percentage rate](https://www.investopedia.com/terms/a/apr.asp) of growth that tracks how a company's dividend payments increase over time. The dividend growth rates aid investors in evaluating stock value through dividend discount models. Based on historical data, dividend growth is a predictor of future growth and profitability.

Many mature companies seek to increase the dividends paid to their investors on a regular basis. Knowing the dividend growth rate is a key input for stock valuation models known as [dividend discount models](https://www.investopedia.com/terms/d/ddm.asp).

### Key Takeaways

*   The dividend growth rate helps investors understand how a company's dividends have increased over time, which can indicate the company's financial health and long-term profitability potential.
*   Calculating the dividend growth rate is essential for using the dividend discount model (DDM), a popular method for valuing stocks based on estimated future cash flows.
*   Companies with a strong history of dividend growth might continue to perform well, offering investors potential long-term benefits through increased dividends.
*   The dividend growth rate can be calculated using different methods, such as the average or geometric approach, and investors can choose any time interval for their calculations.
*   The Gordon Growth Model (GGM), a form of DDM, uses the dividend growth rate to determine the intrinsic value of a stock, which can help investors identify undervalued stocks.

#### What Is A Dividend?

## Break Down of Dividend Growth Rate Fundamentals

Being able to calculate the dividend growth rate is necessary for using the dividend discount model. The dividend discount model is a type of [security-pricing](https://www.investopedia.com/terms/s/security.asp) model. The dividend discount model assumes that the estimated future dividends—discounted by the excess of [internal growth](https://www.investopedia.com/terms/i/internalgrowthrate.asp) over the company's estimated dividend growth rate—determine a given stock's price.

If the dividend discount model shows a higher value than the current share price, the stock is considered undervalued. Investors using the dividend discount model estimate future cash flow to find a stock's intrinsic value.

A history of strong dividend growth could mean future dividend growth is likely, which can signal [long-term](https://www.investopedia.com/terms/l/longterm.asp) profitability for a given company. Investors can choose any time period to calculate the dividend growth rate. They may also calculate the dividend growth rate using the [least squares](https://www.investopedia.com/terms/l/least-squares.asp) method or by simply taking a simple annualized figure over the time period.

## Step-by-Step Guide to Calculating the Dividend Growth Rate

Investors can calculate the dividend growth rate using an average or a geometric method for more accuracy. As an example of the linear method, consider the following.

A company's dividend payments to its shareholders over the last five years were:

*   Year 1 = $1.00
*   Year 2 = $1.05
*   Year 3 = $1.07
*   Year 4 = $1.11
*   Year 5 = $1.15

To calculate the growth from one year to the next, use the following formula:

> Dividend Growth= DividendYear_X_ /(DividendYear(_X_ - 1)) - 1

In the above example, the growth rates are:

*   Year 1 Growth Rate = N/A
*   Year 2 Growth Rate = $1.05 / $1.00 - 1 = 5%
*   Year 3 Growth Rate = $1.07 / $1.05 - 1 = 1.9%
*   Year 4 Growth Rate = $1.11 / $1.07 - 1 = 3.74%
*   Year 5 Growth Rate = $1.15 / $1.11 - 1 = 3.6%

The average of these four annual growth rates is 3.56%. To confirm this is correct, use the following calculation:

> $1 x (1 + 3.56%) = $1.15

## Example of Dividend Growth Rate Application in Stock Valuation

To value a company’s stock, an individual can use the dividend discount model (DDM). The dividend discount model is based on the idea that a stock is worth the sum of its future payments to shareholders, discounted back to the present day.

The simplest dividend discount model, known as the [Gordon Growth Model](https://www.investopedia.com/terms/g/gordongrowthmodel.asp) (GGM)'s formula is:

$\begin{aligned} &P = \frac{ D_1 }{ r - g } \\ &\textbf{where:} \\ &P = \text{Current stock price} \\ &g = \text{Constant growth rate expected for} \\ &\text{dividends, in perpetuity} \\ &r = \text{Constant cost of equity capital for the} \\ &\text{company (or rate of return)} \\ &D_1 = \text{Value of next year's dividends} \\ \end{aligned}$

In the above example, if we assume next year's dividend will be $1.18 and the cost of equity capital is 8%, the stock's current price per share is calculated as follows:

P = $1.18 / (8% - 3.56%) = $26.58.  

## What Is a Good Dividend Growth Rate?

A good dividend growth rate can be different for every investor. Generally, investors should seek out companies that have provided 10 years of consecutive annual dividend increases with a 10-year dividend per share compound annual growth rate (CAGR) of 5%.

## What Is the Difference Between Dividend Yield and Dividend Growth?

Dividend yield is the amount that a company pays out in dividends compared to its stock price. Dividend growth is the increase in the value of dividends that a company pays out over a period of time.

## Do Dividends Grow Every Year?

Whether or not dividends grow every year will depend on the company. Generally, well-established companies that pay dividends will ensure that dividends grow every year; however, it is not guaranteed that dividends will grow every year.

## The Bottom Line

The dividend growth rate is a tool for assessing a company's potential profitability and investment value. It's important for investors to understand a company's dividend payment philosophy and history for making informed investment decisions.

Consistent dividend growth can indicate long-term profitability, which is a favorable attribute for investors seeking reliable returns. Use of the dividend discount model (DDM) and related calculations like the Gordon Growth Model to find a company's intrinsic stock value. While dividends offer a source of income, investors should evaluate overall stock performance and growth potential.