Estimating Growth
The previous post introduced several discounted dividend models for valuing stocks. These models ask for an estimate of growth and required rate of return in order to work. While all estimates require some amount of “guessing” there are some methods which will help you to get more accurate results. Here, we deal with methods of estimating growth.
Past Dividend Growth Rate
Possibly the most direct way to attempt to get dividend growth rates is to analyze dividend growth in the past. Simply put, look at the rate of growth for annual dividends and average it. One can either take a compound average or a mathematical average. This can yield slightly different results. Let’s take an example:
| Year | Dividend | Growth Rate |
| 1 | 1.00 | |
| 2 | 1.05 | 5% |
| 3 | 1.10 | 4.76% |
| 4 | 1.25 | 13.63% |
| 5 | 1.29 | 3.1% |
Average: 6.62% Compound Average: 6.55%
One can also get this data from reuters.com’s “Ratios” fact sheet for stocks. Click here for a link to the sheet for Bank of America. Where dividend information is not available, one can do similar analysis with overall net income growth over prior periods. The assumption would be that if payout rates stay the same, net income growth should grow at the same rate.
Reinvestment Rate
The reinvestment rate is the rate of growth that its company can gain through reinvestment of its retained earnings. This is calculated as retention rate * Return on Equity. Basically, you are assuming that retained earnings will be reinvested and returns will be generated at the same return the company has been able to maintain over the last year.
Note: Retention rate is the ratio of retained earnings over net income. Basically, 1 – the payout ratio. It is often easier to find payout ratio data (use reuters as described above).
Internal Growth Rate
Another way to estimate growth over the next year is to divide retained earnings by total assets. This is the maximum growth achievable without outside financing. This gives an idea of how well a company can grow its if it makes new investments in itself. This gives a better idea of the internal growth capabilities of the company and an idea of where terminal growth may be.
If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.
