What is dividend growth?

Dividend growth is the rate at which a company increases its dividend over time. A company that raises its dividend year after year gives its shareholders an income that grows — often faster than inflation — without any new money being invested. Many income-focused investors look at dividend growth at least as closely as at the current yield.

How it is measured

The growth over one year is:

g = \frac{D_t}{D_{t-1}} - 1

Over several years, the compound annual growth rate is used, as for returns:

g_{\text{annual}} = \left(\frac{D_{\text{end}}}{D_{\text{start}}}\right)^{1/n} - 1

where $n$ is the number of years.

A simple illustration

A company paid €1.00 per share ten years ago and pays €1.97 today:

g_{\text{annual}} = \left(\frac{1.97}{1.00}\right)^{1/10} - 1 \approx 7\%

Compare two stocks bought today for €100 each. One yields 5% and never raises its dividend; the other starts at 2.5% but raises its dividend 8% a year:

	Stock A	Stock B
Dividend in year 1	€5.00	€2.50
Dividend in year 10	€5.00	€5.00
Dividend in year 15	€5.00	€7.34
Total received over 15 years	€75	€68

The growing dividend catches up after ten years and then pulls ahead. And a company able to raise its dividend steadily is usually growing its earnings too, which tends to lift its share price as well.

Why it matters

Protection against inflation. A fixed dividend loses purchasing power every year; a growing one can keep pace.
A signal of financial strength. Companies rarely raise dividends unless they expect their earnings to support them.
A link to valuation. In the dividend discount model, a stock's value depends on the next dividend $D_1$ , the required return $r$ and the long-term growth rate $g$ :

P = \frac{D_1}{r - g}

Small changes in the expected growth rate have a large effect on the value.

Limits

Past growth is not guaranteed. Dividend growth slows as companies mature, and cuts happen, especially in recessions.
Growth can be bought with debt or by raising the payout ratio, neither of which can continue indefinitely.
Share buybacks are an alternative way of returning cash that dividend growth does not capture.

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