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, Et is earnings,
St 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.