There are two ways to make money from owning stocks: The price goes up and you sell it, or you own stock in companies that pay dividends. Dividends are payments from the company to the shareholders based on the number of shares owned. Figuring growth ratio using dividends, which measures the rate at which dividend payments are growing between two points in time, helps you determine if a company is worth investing in.
To figure the growth ratio in the dividends per share, determine the dividends paid previously and the current dividends. First, subtract the prior dividends from the current dividends. Second, divide the change in dividends by the prior dividends. Third, multiply by 100 to convert to a percentage. For example, say that four years ago a stock paid dividends of $1 per share and now pays dividends of $1.20 per share. First, subtract $1 from $1.20 to get 20 cents. Second, divide 20 cents by $1 to get 0.2. Third, multiply 0.2 by 100 to find that dividends have grown by 20 percent.
Accounting for Time
If you're comparing different dividend-per-share growth ratios for different periods of time, you must figure the average growth rate per year to make an accurate comparison. For example, a stock whose dividends have grown by 20 percent in four years is growing faster than one that has grown by 25 percent but taken 15 years to achieve that growth.
First, add 1 to the growth ratio expressed as a decimal -- call this X. Second, divide 1 by the number of years it took to achieve the dividend growth -- call this Y. Third, raise X to the power Y to calculate the average growth per year. Fourth, subtract 1. Fifth, multiply by 100 to convert the decimal to a percent. For example, if a stock's dividends per share grew by 20 percent over four years, add 1 to 0.20 to find X is 1.2. Second, divide 1 by 4 to find Y is 0.25. Third, raise 1.2 to the 0.25 power to get 1.0466. Fourth, subtract 1 to get 0.0466. Fifth, multiply by 100 to get an average growth rate of 4.66 percent each year.
Significance of Dividend Growth
Many investors see consistent dividend growth as a sign of a fiscally sound company. In theory, if a company is consistently paying out and increasing its dividends per share, the company is increasing its profits so that it can continue to pay out those dividends. For example, if a company has 10 million shares outstanding, a dividend-per-share increase of 10 cents means the company is paying out an additional $1 million.
Dividend growth is only one measure of how a company is performing, and it isn't always the best measure. When a company pays out dividends, that's money that the company doesn't have to reinvest in itself, such as for building new stores or conducting extra research and development. If a company is growing, it may choose to keep dividends low and grow the value of the company by expanding. In that case, the price of the stock may increase to reflect the increase in value of the company even though it's not paying out dividends.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."