6.6  Estimating Dividend Growth

There are several ways to estimate the growth rate of dividends.   One way is to use analyst forecasts.  In this case, you “know” what the growth rate is, though you don’t know how the analysts came up with their forecast.  In Valuation Tutor, these are the inputs into the simple model and into the forecast growth variations.  These forecasts are available from the web for firm you are researching by clicking on Analysts in the lower left hand side of the Valuation tutor screen.

As second way to estimate growth is to use the ROE as described in the earlier Business Ratio chapter, where the growth of shareholder equity is:

Here, E_t is earnings, S_t is shareholders equity, and PR is the payout ratio (so the percentage of earnings paid out as dividends).  Note that g is the growth rate of shareholders equity, not of earnings or dividends.  But if shareholders equity has a constant growth rate, and the firm always pays a fixed percentage of earnings as dividends, then both earnings and dividends must grow at rate g.  Therefore, ROE*(1-PR) provides as estimate of the growth rate of dividends.  In a two-stage model, you would only use this for the first stage.  In the second stage, there are some natural limits on the growth rate that we discuss below.

A third way is to calculate the “internal” growth rate of the firm; the growth rate based on ROE is sometimes called the “sustainable” growth rate. The internal growth rate

A fourth way is to calculate the historical growth rate of dividends.  An example of this method is presented next.