Dividend Growth

Dividend Growth is the annualized percentage rate of increase in a company's dividend payment to its shareholders. Imagine getting a reliable pay raise from your investments every year—that's the essence of dividend growth. This concept moves beyond the snapshot of a company's current dividend yield to focus on the future trajectory of your income stream. For investors, particularly those practicing dividend growth investing, a steady and rising dividend is one of the clearest signals of a company's financial strength, disciplined management, and confidence in its future. It shows the business generates abundant free cash flow, more than enough to reinvest for growth while still rewarding its owners. A long history of dividend growth is often a hallmark of a durable, high-quality company, the very treasure that value investing seeks.

A consistent record of raising dividends isn't just a nice-to-have; it's a powerful indicator and a wealth-building engine. It tells a story about the quality of the underlying business and directly impacts your long-term returns.

A company's board of directors is typically very reluctant to cut a dividend, as it signals deep trouble to the market. Therefore, the decision to increase the dividend is a public declaration of confidence. It implies that management expects future earnings and cash flow to be strong and stable enough to support the higher payout for years to come. This kind of financial discipline and predictability is a green flag for investors.

Dividend growth is like pouring gasoline on the fire of compound interest. When you reinvest growing dividends, you buy more shares, which then pay you even more dividends, which in turn grow… and the cycle accelerates. Furthermore, a dividend stream that grows faster than the rate of inflation means your investment income isn't just keeping up with the rising cost of living—it's actively increasing your purchasing power over time.

This is where long-term investors really see the magic. Yield on Cost (YOC) is the annual dividend per share divided by your original purchase price per share. As a company increases its dividend, your YOC gets a boost, regardless of what the stock's current price is.

• Example: You buy 10 shares of “Steady Eddie Inc.” at $100 per share. It pays an annual dividend of $3 per share.
  1. Your initial investment is $1,000.
  2. Your initial dividend yield is $3 / $100 = 3%.
  3. Your initial Yield on Cost is also 3%.
• Five years later: Steady Eddie has been successful and raises its dividend to $5 per share.
  1. Your Yield on Cost is now $5 / $100 = 5%! Your effective income from your original investment has grown by over 66%, providing a fantastic, passive “raise.”

Not all dividend growth is created equal. A smart investor looks under the hood to ensure the growth is both real and sustainable.

A long, uninterrupted track record of dividend increases speaks volumes. It shows a company has navigated different economic cycles while still rewarding shareholders.

• Dividend Aristocrats: These are companies in the S&P 500 index that have increased their dividends for at least 25 consecutive years.
• Dividend Kings: An even more elite group, these companies have raised their dividends for an incredible 50+ consecutive years.

The payout ratio is a critical health metric. It tells you what percentage of a company's profits are being used to pay the dividend.

1. Formula: Payout Ratio = Annual Dividends Per Share / Earnings Per Share (EPS)

A healthy, sustainable payout ratio is typically below 70%. A ratio above 100% is a major red flag, as it means the company is paying out more in dividends than it's making in profit—a situation that simply cannot last.

Ideally, earnings growth should be the engine powering dividend growth. If a company is raising its dividend by 10% per year but its earnings are flat or declining, it's funding the dividend by other means (like taking on debt or depleting cash), which is unsustainable. Look for companies where earnings are growing at a similar or higher rate than the dividend.

While dividend growth is a fantastic tool for identifying quality companies, it's only one piece of the puzzle. Never make an investment decision based on this single metric. A company might have a great dividend history but a weak balance sheet, a deteriorating business model, or be facing disruptive competition. The ultimate goal is a healthy total return, which combines both dividend income and capital appreciation. Use dividend growth as a primary filter to find wonderful businesses, but always complete your full due diligence.