I love dividend paying stocks. They pay you to wait on their share prices to grow with dividends. A company’s dividend growth rate is a good proxy for how much their share price should also grow.
A company’s share price is the present value of all its future cash flows (dividends) according to classic finance theory. So, a simple way to look at it is that a company who is increasing its dividends by 3% to 5% each year should see its share price of its common stock growing at approximately the same rate.
An Example of the Dividend Growth Rate in Action
To give you an example, let’s look at one of my favorite companies, Coca-Cola (Stock Symbol: KO). In 2002, the Coca-Cola company issued a quarterly dividend of 10 cents or 40 cents per year (adjusted for the 2 for 1 stock split that took place in 2012). The share price of Coke at that time was right at about $50 (or $25 factoring the split). Over the past eleven years, Coca-Cola’s dividend has increased to 28 cents per quarter or $1.12 per year. That is a 9.8% annual increase in their dividend.
Currently, Coca-Cola’s stock price has risen to $39.23 this year. That actually equates to only a 4.2% annual rise in the price of their stock (stock split adjusted). Of course, that rise hasn’t been on a straight line but ebbs and flows with the macro economy as well. So, using this dividend growth rate and the share price, it is not out of line to say that Coca-Cola may be undervalued at these levels using this metric alone. Of course, it’s not always wise to put all of your investing eggs into the one basket of a single metric. There’s more to a stock price than that.