How to Calculate Expected Growth Rate of Dividends

Dividend Growth Rate Calculator

Results:

Retention Ratio:

Dividend Payout Ratio:

Expected Growth Rate (g):

function calculateDividendGrowth() { var netIncome = parseFloat(document.getElementById('netIncome').value); var totalDividends = parseFloat(document.getElementById('totalDividends').value); var roe = parseFloat(document.getElementById('roe').value); if (isNaN(netIncome) || isNaN(totalDividends) || isNaN(roe) || netIncome <= 0) { alert("Please enter valid positive numbers. Net Income must be greater than zero."); return; } // Calculation Logic var payoutRatio = totalDividends / netIncome; var retentionRatio = 1 – payoutRatio; if (retentionRatio < 0) { alert("Total Dividends cannot exceed Net Income for this model."); return; } // Expected Growth Rate = Retention Ratio * Return on Equity var growthRate = retentionRatio * roe; document.getElementById('payoutRatioResult').innerText = (payoutRatio * 100).toFixed(2) + "%"; document.getElementById('retentionRatioResult').innerText = (retentionRatio * 100).toFixed(2) + "%"; document.getElementById('finalGrowthRate').innerText = growthRate.toFixed(2) + "%"; document.getElementById('resultContainer').style.display = 'block'; }

Understanding the Expected Dividend Growth Rate

For income investors, predicting how much a company will increase its dividend is crucial for calculating the total return on investment. The Expected Dividend Growth Rate represents the internal rate at which a company can sustain its dividend increases based on its profitability and its policy on reinvesting earnings.

The Fundamental Formula

While historical growth rates are useful, the "fundamental" method for calculating expected growth focuses on how much money a company keeps (plowback) and how efficiently it invests that money. The formula is:

Expected Growth (g) = Retention Ratio × Return on Equity (ROE)

Key Components Explained

• Net Income: The total profit of the company after all expenses and taxes.
• Dividend Payout Ratio: The percentage of net income paid out to shareholders as dividends.
• Retention Ratio: Also known as the "Plowback Ratio," this is the percentage of earnings the company keeps to reinvest in its operations (1 – Payout Ratio).
• Return on Equity (ROE): A measure of financial performance calculated by dividing net income by shareholders' equity. It shows how effectively a company uses investor capital to generate profit.

Real-World Example

Imagine "Blue Chip Corp" has the following financials:

• Net Income: $10,000,000
• Dividends Paid: $3,000,000
• ROE: 12%

Step 1: Calculate the Payout Ratio
$3,000,000 / $10,000,000 = 30%.

Step 2: Calculate the Retention Ratio
100% – 30% = 70% (The company reinvests 70% of its profits).

Step 3: Calculate the Expected Growth Rate
0.70 (Retention) × 12% (ROE) = 8.4%.

In this scenario, the company is expected to grow its earnings—and consequently its dividends—at a rate of 8.4% per year, assuming its ROE and payout policy remain stable.

Why This Matters for Investors

Using this calculator helps investors determine if a company's dividend growth is sustainable. If a company is growing dividends at 15% per year but its fundamental expected growth rate is only 5%, the company is likely increasing its payout ratio to keep up appearances. Eventually, the payout ratio cannot go higher, and dividend growth will have to slow down or stop.

By focusing on Retention Ratio × ROE, you are looking at the engine of the company. A high ROE combined with a healthy retention of earnings is the primary driver of long-term dividend growth.