Dividend growth investing

What is the dividend growth rate?

The dividend growth rate is the percentage change in the annual dividend per share from one year to the next. If a hypothetical Company F paid $1.00 last year and $1.06 this year, it grew 6%: ($1.06 − $1.00) ÷ $1.00 = 0.06.

One year tells you little. Boards often raise dividends in steps, sometimes skip a year, and occasionally cut. That’s why investors usually look at growth over five or ten years, using a compound rate.

Use the dividend per share, not total dividends paid. A company that issues many new shares can raise its total payout while the amount each shareholder receives stays flat, and buybacks can do the reverse.

How do you calculate dividend CAGR?

CAGR = (ending dividend ÷ starting dividend)^(1 ÷ number of years) − 1.

1. Company F’s annual dividend was $1.00 five years ago and is $1.61 today.
2. Divide ending by starting: $1.61 ÷ $1.00 = 1.61.
3. Raise to the power of 1 ÷ 5 = 0.2: 1.61^0.2 ≈ 1.0999.
4. Subtract 1: about 0.10, or a 10% compound annual growth rate.
5. Check it forward: $1.00 × 1.10 × 1.10 × 1.10 × 1.10 × 1.10 = $1.61051, which rounds to $1.61.

Can a lower yield out-earn a higher one?

Compare two hypothetical $10,000 investments held for 20 years. Company H starts at a 5.0% yield and grows its dividend 2% a year. Company G starts at a 2.5% yield and grows its dividend 9% a year. Dividends are taken as cash (not reinvested), the growth rates stay constant, and there are no cuts.

Reading the crossover honestly

Company G’s annual income passes Company H’s in year 12. But Company H collected more in the early years, so cumulative income tells a different story: after 11 years H has collected about $6,084 versus G’s $4,390. G’s running total only overtakes H’s in year 19 (about $11,505 versus $11,420).

So “growth beats yield” is true in this example only for an investor who holds for roughly two decades, and only if every assumption holds. Change any of them and the answer can flip:

• Growth slows. If Company G’s growth fell to 5% after year 5, the crossover would move much further out or never arrive.
• A cut happens. One dividend cut can erase years of compounding for either company.
• Reinvestment. Reinvesting the higher early income from Company H buys more shares sooner, which narrows the gap.
• Share price. This compares income only. Total return also depends on what each share price does.
• Time horizon. Someone who needs income now weighs the early years more heavily than someone who won’t draw on it for 20 years.

How fast does a growing dividend double?

A quick approximation is the rule of 72: divide 72 by the growth rate to estimate the years needed to double. At 9% a year, 72 ÷ 9 ≈ 8 years (the exact figure is 1.09^8 ≈ 1.99). At 2% a year, 72 ÷ 2 ≈ 36 years. It’s an approximation that works best for moderate rates.

Doubling shows up directly in yield on cost. Company G’s dividend income on the original $10,000 grows from $250 to $542.97 by year 10 and $1,285.42 by year 20:

How to review a dividend growth record

1. Compute CAGR over five and ten years and see whether they agree.
2. Check for any cuts or freezes inside the period, which a CAGR can hide.
3. Compare dividend growth with growth in earnings and free cash flow per share.
4. Track the payout ratio over the same period to see whether increases were funded by a rising share of earnings.

What tends to support dividend growth?

Dividend growth ultimately comes from growth in earnings and cash flow per share, or from a rising payout ratio. A payout ratio can only rise so far, so long-run dividend growth that outpaces earnings growth eventually runs out of room. When you review a growth record, check whether earnings and free cash flow grew alongside the dividend, and whether the payout ratio crept up to fund the increases.

The dividend growth calculator lets you test your own starting yields, growth rates and time horizons. Yield on cost is a related way to see how a growing dividend changes the income on your original investment.