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There are several important **financial ratio**s that dividend growth investors frequently use.

One of those calculations that I use almost every single day is the yield on cost (YOC).

Calculating my portfolio’s yield on cost let’s me track the return I am getting in the form of dividends for owning stock.

Then there are those ratios that are used by many to screen for quality dividend stocks.

For example, before buying a stock … I always check that the **P/E ratio** (price to earnings) is under 20. And I make sure that the payout ratio is under 60.

In addition to screening stocks for specific P/E and Payout Ratio’s … I am also constantly reviewing past **dividend growth rates**.

## What is the Dividend Growth Rate

The dividend growth rate of a stock, is the annual percentage dividend increase during a period of time for a company.

While the time period can be any amount of years … dividend investors commonly use one of the following: **1-year, 3-year, 5-year, or 10-year**.

The simplest way to get this information is to use resources like the U.S. Dividend Champions list that is published every month.

It is also possible to calculate these growth rates on your own …

## How to Calculate Dividend Growth Rate

In order to calculate the **dividend growth rate (DGR)** of a stock, you will need to know what period of time you would like to calculate for?

If you would like to calculate the 3 Year DGR for example, then you will need the annual dividends for the past 4 years.

Then you will need to use a basic calculation to figure out the growth rate (hopefully) between two consecutive years.

For example, you could use an equation that looks something like this to figure out the most recent growth rate –

**DGR = (Dividend (this year) / Dividend (last year)) – 1**

That equation above is a basic calculation showing the percentage increase (or decrease) between two consecutive years. So if you also wanted to include more years, you need to repeat this process for each yearly interval and then take the average.

I personally use the 5 year and 10 year **growth rates** the most for my analysis.

Most of the time, I am probably not going to try and calculate a DGR (especially the 10 year) if it is already available to me. However, it is good to have an understanding of how the number is calculated.

## Calculating Dividend Growth Rates

In order to test out how to calculate the dividend growth rate of a company, I find it helpful to look at a real example.

Let’s calculate the dividend growth of **Aflac (AFL)** over the past 5 years. For the purposes of this example, we will calculate the 1-year, 3-year, and 5-year dividend growth rates for the company.

So … in order to calculate out 5 years of growth rates, we will need to take the past 6 years worth of annual dividends paid by Aflac.

Here is a list of the company’s annual dividends –

- 2016 – $1.66
- 2015 – $1.58
- 2014 – $1.48
- 2013 – $1.42
- 2012 – $1.34
- 2011 – $1.23

As you can see from the data above … the company has consistently raised it’s dividend for over the past 5 years.

*Note – The company has actually increased it’s dividend for over 30+ consecutive years.*

### 1 Year DGR

The 1 year dividend growth rate is very easy to calculate.

You simply take the percentage increase in dividend over the past year. In this case, we are looking at the 2016 dividend of $1.66 and will divided it by the 2015 dividend of $1.58.

It would look something like this –

**($1.66 / $1.58) – 1 = 0.0506**

So the 1 year DGR for Aflac = **5.1%** after rounding.

*This means that Aflac gave their shareholders a 5.1% raise between 2015 and 2016 – not bad.*

### 3 Year DGR

The 3 year dividend growth rate is just an extension of the previous calculation … but averaged out over the past 3 years.

So … you preform the same calculation as in the 1 Year DGR for the past 3 years.

We will need the annual dividend amounts for the past 4 years for Aflac, which are – $1.66 (2016), $1.58 (2015), $1.48 (2014), and $1.42 (2013).

Then we calculate the return between each consecutive year as follows –

- 2015 to 2016: 5.1% (calculated already)
- 2014 to 2015: ($1.58 / $1.48) – 1 = 6.8%
- 2013 to 2014: ($1.48 / $1.42) – 1 = 4.2%

The last step is to take the average of the 3 years growth –

**(5.1% + 6.8% + 4.2%) / 3 = 5.4%**

As an Aflac shareholder for the past 3 years, I know that my dividend income stream from this stock has given me on average … a 5.4% raise.

That is certainly not as much as my employer gave me!

### 5 Year DGR

The final dividend growth rate we will illustrate for Aflac is the 5 Year DGR.

Again, just the like 1 and 3 year growth rates … the 5 year rate is the average dividend increase over that period of time.

In order to calculate it, we will need the annual dividend amounts for the past 6 years for Aflac, which are – $1.66 (2016), $1.58 (2015), $1.48 (2014), $1.42 (2013), $1.34 (2012), and $1.23 (2011).

Then we calculate the return between each consecutive year as follows –

- 2015 to 2016: 5.1% (calculated already)
- 2014 to 2015: 6.8% (calculated already)
- 2013 to 2014: 4.2% (calculated already)
- 2012 to 2013: ($1.42 / $1.34) – 1 = 6.0%
- 2011 to 2012: ($1.34 / $1.23) – 1 = 8.9%

The last step is to take the average of the 5 years growth –

**(5.1% + 6.8% + 4.2% + 6.0% + 8.9%) / 5 = 6.2%**

For anyone who has owned shares of **AFL** stock since 2011 … they have been given an average yearly 6.2% raise!

That is not as high as some companies … but still a very solid rate of growth for dividend income.

## Why Should You Use the DGR?

When selecting quality dividend growth stocks, it would be a mistake to focus only on the current yield of a company.

For example, a company that you are looking at may have a current yield of 4%. That means that for every $100 of stock you own in the company … you will receive $4 a year in dividends. Not a bad return at all.

But … while the company may have a great current yield … they may also have a low DGR.

For example, we own shares of Verizon Communications (VZ) in our dividend growth portfolio. At the time of this writing, VZ stock had a current yield of around **4.3%**.

But as great as the current yield is … the company does not have a very high growth rate compared to other dividend stocks. For example, the 5 year DGR is 3.0% and the 10 year DGR is 3.4%.

If the company followed it’s 5 year DGR for 2017, each share I own would pay me **$2.34** in dividends for the year compared to **$2.27** in 2016.

That is certainly an increase, but it is only a 3% raise and about $.06 more per share for the entire year.

I like to get a 6%+ raise personally!

Should low DGR stocks like VZ be avoided? No.

But investors need to diversify across different sectors of stocks, as well as the types of dividends stocks (ie – REIT’s, high growth, high yield, etc.)

Just remember to factor in several financial ratios like the dividend growth rate when you are selecting and analyzing stocks.

*Full Disclosure – At the time of this writing, we owned shares in the following stocks noted in this post – AFL, and VZ. The material above is not a recommendation to buy. Please do your own research on a company before deciding to invest.*