For investors who buy stocks, tracking portfolio growth is a regular part of daily life. For the companies who manage shares in their business, calculating that growth is key to keeping shareholders happy. But predicting future stock performance is always a challenge since markets can be predictable. There are two models for calculating future dividend growth – constant growth and nonconstant growth – and each is dramatically different from the other.
The primary difference between a constant and non-constant growth dividend model is the perspective on future growth. A constant growth model assumes that growth rates will stay largely identical in the future to where they are now, while a non-constant growth model believes that these rates can change at any point.
What Is a Constant Growth Dividend Model?
Analysts, shareholders and businesses all seek to predict what a stock will do in the coming years. Whether it’s for the next few weeks or the next few years, this calculation can be tricky. One of the easiest ways to calculate dividend growth is to come from the assumption that the company’s growth will continue at the same percentage rate that it’s currently demonstrating.
The best way to determine if this is the formula you should use is to look at the past performance of the stock. Has it maintained the same rate of growth over the years, or do you see fluctuations? If you see a steady percentage from one year to the next, you can safely assume that you’ll continue to experience that growth for at least the foreseeable future. This is the easiest form of valuation, since you need to simply apply a percentage growth rate to your current rate, then continue applying it for future years to determine what your stock will be worth year after year.
What Is a Nonconstant Growth Dividend Model?
Nonconstant growth models assume the value will fluctuate over time. You may find that the stock will stay the same for the next few years, for instance, but jump or plunge in value in a few years after that. In that case, you can calculate for steady growth for those early years, then estimate upward or downward movement at whatever point you see necessary.
As with constant growth, one way to lay out your calculation is to look at past performance. Were the fluctuations related to market conditions or can you somehow correlate it to the business’s activities? If the fluctuations were random, it can be far more difficult to try to predict them moving forward.
Calculating Stock Value
Once you’ve determined a business’s growth structure, you can apply a formula that will help plan for future growth. You would need to first determine the growth rate from one year to the next. So, if your stock was worth $0.30 per share last year at this time and is worth $0.40 this year, you enjoyed a $0.10 growth during that time. Since $0.10 is 33.3 percent of $0.30, you can reasonably assume, if you expect constant growth, that you’ll have 33.3 percent growth next year and the year that follows.
If, however, growth is nonconstant, you’ll need to figure what growth you can reasonably expect in the years in question. If you had 33.3 percent growth last year, but you’ve noticed that your company’s growth is increasing by 2 percent each year, you can estimate 35.3 percent next year. This isn’t guaranteed, but neither constant nor nonconstant growth predictions are foolproof.
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.