In this article, I have shown 3 Ways to calculate dividend growth rate.
- Simple average of yearly growth.
- Average of multi-period CAGR (compounded annual growth rate).
- Regressing of natural log of dividend per share on a time series index
I have illustrated the 3 ways to calculate dividend growth rate of a company using ITC as an example. For this exercise, I have used data from 2001 to 2013.
Background on ITC
ITC is a diversified Indian conglomerate in five segments.
- Fast Moving Consumer Goods (FMCG)
- Paperboards & Packaging
- Agri Business
- Information Technology
ITC is the largest producer of cigarettes in India, and has a reasonably stable business model.
3 Methods to Calculate Dividend Growth Rate
Method 1: Use Simple Year on Year Growth Average.
In this method, I first calculate the yearly dividend growth for every year. The calculated dividend growth rate is the simple average of all these yearly numbers.
The historical growth rate using this method is 31%.
The predicted values seem to be overstated significantly in 7 out of 13 cases.
Method 2: Use an average of a multi-period Compounded Annualized Growth Rates (CAGR).
In this method, I first calculate a 3 year (or 5 year) dividend CAGR. The calculated dividend growth rate is the average of all these multi-period CAGRs.
The historical growth rate in this case is estimated to be 28%.
The variability in the deltas of actual versus predicted is also reasonably low.
Method 3: Use a Regression of natural log of dividend on a time series.
The estimated growth is around 24% when we use regression to calculate dividend growth rate.
This number has been obtained by regressing ln(DPS) [ the natural log of dividend per share] on a simple time series index.
In this specific example, this method appears to be more conservative than the two above methods in that it under-states the estimated dividends.
Results of regression are given below.
A rather high R-Square of 96% in this model would seem to indicate a good fit to an exponential time series.
So which of the three ways should we use to calculate dividend growth rate?
There is no right or wrong answer to this.
Professor Damodaran has a very good discussion on this in his book on valuations and one may refer to that for a more nuanced discussion.
In conclusion, any one of these / or an average of some or all of them may be used, depending on the context of the underlying problem. The most important thing is that one should exercise caution in applying these numbers, as there is no guarantee that the future will be same or even remotely similar to the past.
I hope you enjoyed this post on how to calculate dividend growth rate. Please feel free to share and leave your comments.
You may also like:
This is an academic exercise. It is not a recommendation to BUY/ HOLD / SELL ITC.