Why Dividend Growth Rate is so Important (2022)

It is one of the most underappreciated metrics in the stock analysis game. 

This is basically the magic elixir that boosts the compounding effect for dividend investors.  It happens organically and passively and that is probably why it is a concept that gets overlooked by a lot of investors.

Dividend growth investors know the metric like they know their phone numbers. 

It is the dividend growth rate. 

It allows passive income dreams to come true.  

The dividend growth rate metric measures how much a company’s annual dividend per share has increased over a certain time period. Common time periods are 1, 3, 5 and 10-year periods. 

 Read on to find out how powerful the dividend growth rate can be.

A Dividend Growth Example 

If Company X pays out dividends per share as

YearDividend Per Share ($)
12.00
22.20
32.42

Then you can see that each year the dividend growth rate is 10% (if you multiply $2.00 by 1.1, you would get $2.20, and if you multiply $2.20 by 1.1, you would arrive at $2.42). 

You might have focused on the dividend per share calculation and you didn’t see the magic, but do not worry, there is no slight of, uh, keyboard here.  

To show you the magic, let’s add in the fact that you buy 50 shares of Company X at the beginning of year 1. 

YearSharesDividend Per Share ($)Total Dividends Received ($)
1502.00100
2502.20110
3502.42121

In your first year, the dividends per share are $2.00.  You receive $100 in dividends for your 50 shares.

Year 2 comes and goes and you partied hard and maybe even met somebody who could be “the one”. 

You still have your 50 shares of Company X, but since the company increased their dividend by 10% you now collect $110 in dividends (a 10% increase on the $100 you received in year 1).  Remember, the dividend per share is now $2.20 multiplied by the 50 shares you still hold. 

In year 3, another 10% dividend increase is announced.  You’ve done nothing but hold the same 50 shares you had the previous two years and you now collect $121 in dividends.  That’s a 21% increase over the dividends you received in year 1. 

You probably think this is not a realistic scenario, and maybe 10% is a little more on the ambitious side. 

So let’s lower the dividend growth rate a little. 

Another Dividend Growth Example 

Let’s try an example with a dividend growth rate average of 7% a year for 20 years. 

Let’s give the stock of Company X a price of $67 and the dividend is $2.00 per share (annually) in the first year. So the starting yield is 2.99%. 

You buy 50 shares, so your initial cash outlay for this stock is $3,350.  Here are the dividends received for the next 20 years. 

You will take the dividend payments in cash and you will not reinvest them, so your shares will stay at 50 because you do not buy or sell over the next two decades.

Shares = 50

Purchase Cost =$67 per share

Total invested = $3,350

Dividend Growth Rate = 7% per year 

YearDividend Per Share ($)Total Dividends Received ($)Yield on Cost (%)
12.00100.002.99
22.14107.003.19
32.29114.493.42
42.45122.503.66
52.62131.083.91
62.81140.264.19
73.00150.074.48
83.21160.584.79
93.44171.825.13
103.68183.855.49
113.93196.725.87
124.21210.496.28
134.50225.226.72
144.82240.987.19
155.16257.857.70
165.52275.908.24
175.90295.228.81
186.32315.889.43
196.76337.9910.09
207.23361.6510.80
Total $ 4,099.55 

There is a lot to unpack here.  First, you notice that the dividend growth takes time to gain momentum, but eventually it does grow. 

If the dividend per share annually increases by 7% a year you go from earning $2.00 in dividends per share in year 1, to $3.00 per share in year 7.  At some point between years 11 and 12 you receive $4.00 per share in dividends before ending up at a whopping $7.23 in dividends per share in year 20. 

In other words, your yearly dividends have gone up by more than 3.5 times the original $2.00 per share amount in two decades. 

Now here is the most fascinating part.  Your total dividends received for the 20 years would be $4,100 (we’re rounding up here).  That’s real money that was paid out, not paper gains.  That’s more than your initial investment of $3,350!   

You’ll notice a fourth column in the table labelled “Yield on cost”.  A lot of investors say it is meaningless, and that is open for debate.  However, it does show you how hard your money has been working for you.  You can figure out the yield on cost by dividing the total dividends received in a given year by your investment amount. 

For instance, in year 10, you received $183.85 in dividends and if you divide it by the $3,350 initial investment to get the 5.49% yield on cost. 

Remember, you bought the shares of this stock at an original yield of 2.99%, so your money is making money by compounding and there is the proof.  The cool thing about this is that by year 15, your return from dividends alone is 7.7% which is good enough to match average market return for the S&P 500 and S&P TSX 60 Indices over the past 20 years.

Pretty cool huh?  There’s one more thing, though. 

Dividend growth stocks have two ways of making money through dividends and capital appreciation (the stock price rising). 

The table above was only discussing the dividend portion of the return.  There was nothing said about the price of the stock changing over the 20-year period.

Dividend Growth Stocks and Price Drops

There is a possibility that the price of Company X’s stock might drop from the $67 amount you purchased it for 20 years prior. 

How far? 

Maybe it dropped $10, to $57 per share. 

Ouch, but we still have a market value of $2,850.  So we lost out on $500 because we purchased the 50 shares for $3,350.

But wait.  What’s that you say? 

Oh yeah.  You collected $4,100 in dividends.  The total return is what matters and that means we need to add up the market value + the dividends collected.  That’s $2,850 + $4,100 = $6,950.  That’s more than double our original invested amount and the stock went down in price over the 20 years. 

This next part is rather unrealistic but let’s suppose in year 21 the company stock gets crushed after the company causes an environmental disaster and the stock plummets the next day to $0, as the company goes bankrupt.

Well, the total return is still equal to the market value + the dividends collected ($0 +$4,100). So you still walked away with a $750 (remember the cost originally to purchase the shares was $3,350) profit after your stock lost all its value, thanks to the dividends you received as cash.

If the same thing happened to a non-dividend paying stock, you would have been left with $0.

Editor’s note: There is one caveat though, if you re-invest your dividends back into the same stock, you would be left with $0 as well.

For a dividend stock:

Total return = stock price appreciation (gains) + all dividends received

For a growth stock (non-dividend paying) :

Total return = stock price appreciations (gains)

As mentioned before, you have two ways to make money from dividend stocks and only one way from a non-dividend paying stock. 

To compensate for that fact, growth stocks offer a better chance at a larger capital gain than a dividend-oriented stock. 

Why is a Dividend Stock Price Drop So Beneficial?

When the stock price decreases, you pay less to secure more current and future income.  If you’re in the accumulation phase prior to retirement this is great news for you.

Price Drop Scenario(A)(B)
Shares100100
Price Per Share ($)2522
Total Cost ($)2,5002,200
Dividend Per Share ($)1.261.26
Total Dividends ($)126126
Cost Per Dividend Dollar ($)19.8417.46
Dividend Yield5.04%5.73%

In the table above, you own 100 shares of Company X and it pays $1.26 in dividends per share annually.  

There are two scenarios to consider here, at two different price points.

In scenario A, the cost to buy shares of Company X is $25 and in scenario B it is only $22 after the stock price drops because the stock market dropped overall.  The dividends paid are the same for both scenarios at $126.

In Scenario A, you spend $2,500 to buy 100 shares, while in Scenario B you only pay $2,200.

Your cost per dividend dollar received drops from $19.84 to $17.46 after the price goes down by $3.00 per share.

The cost per dividend dollar is the inverse of the dividend yield. That means if you find the dividend yield is 5.04% as it is in Scenario A, the equation is:

Cost per dividend dollar = 1/dividend yield

Cost per dividend dollar = 1/0.0504

Cost per dividend dollar = $19.84 

In scenario A, you are paying $19.84 to buy one dollar of dividend income.  

In scenario B, after the $3 price reduction per share, you are only paying $17.46 to buy one dollar of dividend income.  So you save $300 on your purchase and you can use that money to buy another stock or ETF.  

You can buy more dividend income for less.  When a stock price drops and the fundamentals of the business have not changed, then the stock is basically “on sale” just like a pair of jeans. 

With dividend investing, you are spending your hard-earned money to buy current and future income in the form of stock.  At a high level, it is the same concept as owning real estate except instead of buying a home or building and renting it out, you buy part-ownership in a company through a stock or ETF purchase.  

In the real estate scenario, your tenants are paying you income by paying rent and in the investing scenario the company is paying you income in the form of a dividend. 

Outside of that fact, real estate and investing are vastly different asset classes .

How Dividend Income Increases Affect Stock Prices

Lowell Miller, in his book the “Single Best Investment”, stated that if an asset produces more income, the asset becomes more valuable itself.  This is such a simple, but powerful statement. 

Let’s say you purchase two rental condo properties in the same building.  You currently have tenants paying $1,500 per month for your condo unit.  You decide that being a landlord is not your cup of tea, so you list the properties and some real estate investors want to purchase them. The top bid comes in at $400,000 for each property. 

You decide that is too low. You want the big payday right now so you can retire and play Wordle all day and night. 

So you take the listings down.  One unit you keep the same.

You make some modern upgrades in the other unit such as adding quartz countertops, bamboo hardwood and stainless steel appliances.  

You re-list both rental units and you can now easily receive $1,800 per month for the upgraded unit because professionals like the proximity of the location to the work district and appreciate the upgraded standard of living your unit provides.  

Your other rental unit continues to garner $1,500 per month. 

After one year you decide you want to sell the condo units and invest some of the profits into a new cryptocurrency invented by vampires called Bitecoin.   

So you place your rental units on the market again and you are surprised that investors are willing to pay $450,000 for the upgraded unit, even though the non-upgraded unit is still only commanding $400,000.  

What happened here? 

As the rent received grew from $1,500 to $1,800 per month, so too did the value of the upgraded property from $400,000 to $450,000.  Investors appreciated that each year they would receive $3,600 more in rent per year and were willing to pay an extra $50,000 upfront for that future benefit. 

That is the same way to think about dividend growth stocks.  As the dividend grows whenever the Board of Directors announces a new dividend increase, more investors will be tempted by the increased income. Investors should be willing to pay more for the income boost provided by the business.

An increase in buyers for any stock will push the stock price upwards in the long run.  As you can see, the income generated from the growing dividends pushes the stock price up. 

In general, if everything else holds the same (usual P/E ratio, no negative sentiment against the industry or company etc.) then a doubling of the dividend in a medium to long-term timeframe should result in a doubling of the stock price as well.  

Examples of Dividend Increase vs. Stock Price Increase in the Long–Term

Here are a few numerical examples. 

Below is a table of Pepsi’s (PEP) dividends paid out per year from 2012 through 2021.  You can see that the dividend grew from $2.11 per share annually in 2012 to $4.20 per share in 2021.  The dividend was almost double (1.99 times higher) what it was in 2012.

The compound annual growth rate (CAGR) for the dividend was 7.13% for the ten years. 

YearPEP Annual Dividend ($)Dividend Change (%)
20122.11
20132.214.74
20142.4510.86
20152.7211.02
20162.916.99
20173.127.22
20183.4711.22
20193.778.65
20203.965.04
20214.206.06

In January 2012, the share price was approximately $66.  By the end of December 2021, the price was hovering around the $170 range (2.57 times higher) what it was in 2012. Recall that the dividends increased by 1.99 times over this timeframe.  

No one knows where a stock’s price will be in a decade’s time.  However, the dividend growth rate is a pretty good indicator of the direction a stock’s price moves in the long term. 

In 2012, when the stock price was $66, the dividend per share was $2.11.  That meant the dividend yield was roughly 3.20%.  Now suppose that the price stayed the same for the entire 10-year period from 2012 to 2022. 

If Pepsi made all the profits that they did in the next ten years and grew their dividend to $4.02 per share by the end of 2021, that would have made the dividend yield 6.09% if the price continued to stay at $66.  

To get a world-class blue-chip dividend growing company at that price would be too tempting for investors. For the dividend alone, investors would start snapping the stock up like crazy. 

In turn, this would drive the price higher as there would be more buyers than sellers.  This is a good example of how dividend growth can be a driver of stock price appreciation.        

Here is an example of a blue-chip Canadian bank, Royal Bank and all the dividends they paid out annually from 2012 to 2021. 

YearAnnual Dividend ($)Dividend Change (%)
20122.28
20132.5310.96
20142.8412.25
20153.088.45
20163.245.19
20173.487.41
20183.778.33
20194.077.96
20204.295.41
20214.320.70

Once again, you can see that the dividend payout was $2.28 per share in 2012 and that increased to $4.32 in 2021.  That means the dividend increased by 89% in that timeframe. 

If you held 100 shares of Royal Bank stock in 2012, you would have received $228 per year in dividends.  By 2021, the dividend amount would have skyrocketed to $432. That’s for doing nothing the whole time except keeping all your shares. 

Not too shabby. 

If Royal Bank’s stock price stayed stagnant from January 2012 when it was around $53 per share, but the dividend growth continued along as it actually did and ended at $4.32 per share in 2020 then the dividend yield in December 2021 would be 8.15%.  What a juicy dividend yield that would be for arguably the best bank in Canada. 

As it turns out, the Royal Bank stock price in December 2021 was $135 at the year’s end.  This represented a 154% increase in the stock price from January 2012.  Remember, the dividend increased by 89% during that same time period.  

All Canadian banks were told they could not raise dividends during the height of the pandemic, which explains the much lower dividend growth in 2020 and 2021.  By year end 2021, investors knew that Royal Bank’s next dividend increase would be 11.1% which would have influenced the price as well. 

There you have it, two world-class companies that increased the amount of dividend income they produced each year (about 7% each) and caused their own share price to grow.  Investors will pay a higher price for an asset that increases its income and generates a lot of profits, much like the upgraded condo unit. 

Keep in mind that at the end of 2021, the stock markets worldwide were at all-time highs, and the price appreciation may be ahead of itself and may correct throughout 2022 and beyond.

Dividend Growth Rate Conclusion

A company’s dividend growth rate is a very useful metric as it tells you how strong the company has been and how strong it feels it will be going forward. It should be an integral metric when you are researching dividend growth stocks for your portfolio.

How much do you care about a company’s dividend growth rate?  Feel free to share below so that new dividend investors can focus on avoiding those first.

Dividend Growth Rate FAQs

What’s a good dividend growth rate?

A good dividend growth rate is between 5 to 7% annually. That will handily beat inflation in most years and can compound quick enough that after 20 years you could reasonably expect a blue-chip company’s annual dividend to triple.

Are dividends good for growth?

Dividend growth investors can see their dividend income grow organically through planned company dividend increases. This increases the compounding effect, which can build wealth quicker. While growth stocks have the capacity to earn patient long-term investors great returns, they do so with greater volatilty than divided stocks.

Is Apple a dividend growth stock? Is Tesla a dividend stock?

Apple is a dividend growth stock that has paid dividends in consecutive years since 2012. Tesla is not a dividend stock, it is a growth stock.

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