What is Dividend Growth?
Dividend growth refers to the increase in a company’s dividend payments to its shareholders over time. By increasing dividends, companies increase shareholder returns and signal confidence in creating strong future cash flows.
Overview of Dividends and Their Importance to Investors
Dividends are portions of a company’s earnings distributed to shareholders, usually in the form of cash payments or additional shares. For long-term investors, dividends provide a steady income stream and help give investors a steady return even during times of market volatility. Companies that consistently increase dividends are often perceived as stable and financially sound, making them attractive to investors who prioritize steady income and lower risk.
A classic example of a dividend-paying company is Procter & Gamble (P&G). The company has been paying dividends for 134 consecutive years and has increased its dividend annually for 68 consecutive years. For dividend growth investors, P&G represents a stock that provides a source of income through dividends, and dividend growth helps hedge against inflation.
What is the Dividend Growth Rate?
The dividend growth rate measures the annual increase in a company’s dividend payments. For long-term investors, the dividend growth rate may be more important than the current dividend yield because a company that will grow dividends might pay investors more over time.
Formula for Calculating Dividend Growth Rate
Investors can calculate the dividend growth rate over one year with a simple percent change formula. If investors are looking to find average dividend growth rate over a multi-year time period, it’s best to use the Compound Annual Growth Rate (CAGR) formula.
TIKR calculates a stock’s dividend growth rate for you, so you never need to calculate this by hand, but it’s still helpful to understand the calculation.
Analyze stocks quicker with TIKR >>>
Single-Year Dividend Growth Calculation
This method looks at the percentage change in dividends over a specific period. The formula is:
[Ending Value / Beginning Value – 1] x 100
For instance, Coca-Cola paid $1.76 in dividends per share for fiscal year 2022 and increased dividends per share to $1.84 in fiscal year 2023. That means they increased dividends 4.5%:
Dividend Growth Rate = [1.84 / 1.76 – 1] x 100
Dividend Growth Rate = 4.5%
Multi-Year Compounded Annual Growth Rate (CAGR) Calculation
The CAGR calculation helps investors calculate the average dividend growth over a multi-year period. The formula for CAGR is:
CAGR= [(Ending Dividend / Beginning Dividend)^(1 / Number of Years) – 1] x 100
The CAGR formula is the same as the single-year formula, except it raises by (1/n), where n is the number of years.
Again – TIKR calculates all of this for you – so you’ll never have to break out the graphing calculator to calculate dividend growth by hand.
Example
Coca-Cola’s (KO) dividends per share grew from $1.56 to $1.84 over five years. TIKR already calculates the CAGR over this time period as 3.4%, but we’ll also look at the formula you can use to calculate this by hand:
CAGR = [(1.84 / 1.56)^(1 / 5) -1] x 100
CAGR = [(1.179)^(1 / 5) -1] x 100
CAGR = (1.0335-1) x 100
CAGR = 3.4%
Stocks with consistent dividend growth can be attractive for dividend growth investors.
Explore high-yielding dividend growth stocks >>>
Benefits of Dividend Growth Investing
Dividend growth investing involves selecting stocks of companies that not only pay dividends but also regularly increase them. This investing strategy has many benefits for investors:
- Compounding Returns: Reinvesting growing dividends leads to exponential growth through compounding over time.
- Reliable Income: Dividend growth stocks provide a stable and increasing income stream, even in volatile markets.
- Lower Risk Stocks: Companies that grow dividends are typically financially strong and less volatile than non-dividend-paying stocks.
- Price Appreciation: In addition to growing dividends, dividend growth investors will most likely see the bulk of their return come from the stock’s share price rising over time.
- Long-Term Focus: Dividend growth investing encourages investors to have a long-term mindset, fostering wealth-building through income and capital appreciation.
Potential Risks and Downsides with Dividend Growth Investing
While dividend growth stocks offer many benefits, there are also potential risks:
- Overvaluation: Dividend growth stocks can sometimes be overvalued, leading to lower future returns.
- Dividend Cuts: Even strong companies may cut dividends to conserve cash in challenging economic conditions. This can cause the company’s share price to fall, making dividend income less reliable for investors.
Key Factors That Affect Dividend Growth
Several factors can influence a company’s ability to grow its dividends:
- Company Earnings and Profitability: A company’s ability to consistently grow its earnings is one of the most important factors for dividend growth. Companies with stable and predictable earnings, like utilities or consumer staples, tend to have consistent dividend policies.
- Payout Ratio and Retention Ratio: Companies with low payout ratios that retain most of their earnings will likely be better able to grow dividends over time. A high payout ratio might signal that a company has limited growth potential for its dividends and indicates an increased risk of a future dividend cut.
- Industry Trends and Economic Conditions: Companies operating in stable industries are better positioned to grow dividends. For example, companies in sectors like consumer staples, which experience less cyclical fluctuation, are more likely to maintain consistent dividend growth.
Diversifying with Dividend Growth Stocks in a Portfolio
Including dividend growth stocks in a diversified portfolio can provide a balance of income and growth, reducing overall risk. Stocks from various sectors, such as healthcare, consumer goods, and utilities, can offer diversification benefits and steady income streams.
Common Mistakes to Avoid in Dividend Growth Investing
- Overreliance on High Dividend Yield: Stocks often have abnormally high dividend yields because the stock price fell due to problems in the underlying business. Plenty of stocks have high dividend yields, but it’s important to look closely into the state of the underlying business to ensure the stock isn’t a yield trap.
- Not Considering Dividend Payout Ratios: Even if a company has a history of high dividend growth, it might not be able to sustain that growth if the stock has a high payout ratio. The payout ratio measures the percentage of a company’s earnings that go into paying dividends. We generally recommend looking for stocks with a payout ratio below 70%.
How to Identify High Dividend Growth Stocks
Screening for Dividend Growth Stocks
Investors can find high-dividend growth stocks by screening the market for high-quality dividend-paying companies. Some qualities to look for in dividend growth stocks include:
- Consistent Earnings Growth: Companies that consistently increase earnings are more likely to grow dividends.
- Low Payout Ratios: Firms with payout ratios below 70% are generally considered capable of sustaining dividend payments. Companies with lower payout ratios have more room to grow dividends
- Strong Cash Flow: Companies generating robust free cash flow, like Apple or Johnson & Johnson, are well-positioned to continue paying and increasing dividends.
Dividend Growth Screener Example
Here’s an example screener with the criteria you could use to screen for high-dividend growth stocks:
Criteria:
- Grown and projected to grow EPS at over 10% annually
- Growth dividends at over 5% annually
- Dividend yield in the last 12 months over 2%
- Payout ratio below 70%
- Net debt / EBITDA under 3x
This screen ensures that companies are growing earnings, which allows them to grow dividends. As safety measures, it also ensures that the company isn’t paying out too much of its earnings as dividends and doesn’t have too much debt.
This screen found 520 stocks, including some great dividend growth stocks like Automatic Data Processing (ADP), Starbucks (SBUX), and Illinois Tool Works (ITW).
Find the best dividend growth stocks with TIKR’s screener >>>
Difference Between Dividend Yield and Dividend Growth Rate
Dividend yield measures the annual dividend payment as a percentage of the company’s stock price. As an example, Coca-Cola’s current share price is about $71, and it paid $1.89 in dividends in the last 12 months. Therefore, Coca-Cola’s dividend yield is about 2.7%.
The dividend growth rate focuses on the rate at which dividends increase over time. Investors should consider a stock’s dividend yield and dividend growth rate when evaluating dividend stocks because a company with a high dividend growth rate can eventually pay more dividends than a company with a high dividend yield.
FAQ Section
What is a good dividend growth rate?
A dividend growth rate is when dividends grow above 5% annually. The company should also have a payout ratio below 70% and a high-quality business model.
How do you find the dividend growth rate of a stock?
Investors can calculate a stock’s dividend growth rate using a simple percent change formula (Ending Value/Beginning Value) to measure dividend growth over a single year and the CAGR formula to measure dividend growth over a period of time.
What are the best dividend growth stocks to buy?
The best dividend growth stocks to buy are generally growing EPS at over 10% annually, dividends at over 5% annually, and a payout ratio below 70%. Many great companies fit these criteria, and after doing more research on them, you could find good dividend growth stocks to buy!
How often should you reevaluate your dividend growth stocks?
Investors should reevaluate their holdings at least annually or when there is a significant change in the company’s fundamentals or market conditions.
Can dividend growth stocks provide a stable income?
Dividend growth stocks can provide a stable, growing income for investors, but it’s important to remember that dividend-paying companies can cut their dividends at any time. That’s why it’s recommended to build a diversified portfolio of dividend stocks if you’re looking to make a portfolio that maximizes dividend income.
TIKR Takeaway
Dividend growth investing allows investors to benefit from stock price appreciation while also getting the compounding returns from a growing dividend income stream.
The TIKR Terminal offers industry-leading financial information on over 100,000 stocks, helping you find the best dividend growth stocks today.
TIKR offers institutional-quality research with a simple platform made for individual investors like you.
Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold positions in any of the stocks mentioned in this article. Thank you for reading, and happy investing!
