: I know John Heinzl is a fan of companies that raise their dividends. Which is better: a stock with a high dividend that grows at a modest pace, or a stock with a modest dividend that grows at a high pace?In finance, there’s something called the dividend discount model. Also known as the Gordon growth model, it’s an equation for calculating a stock’s current worth based on all of its expected future dividend payments, discounted back to their present value.
Similarly, a stock yielding 3 per cent, and whose dividend grows at 7 per cent, should also produce an annualized total return of 10 per cent – at least in theory. Again, this assumes all dividends are reinvested. So, according to the formula, it’s not the yield or dividend growth rate in isolation that matters, but the combination of the two.
The Gordon growth model is far from perfect. A key assumption of the model in its most basic form is that the dividend will grow at a constant rate, which never happens in real life. The model also assumes that the share price will rise at the same rate as the dividend, which, again, is not necessarily the case.