This article looks at how I measure dividend growth along with other factors that support sustainable dividend growth.

## Table of Contents

- Measuring dividend growth
- Calculating a company’s Growth Rate
- Burberry’s Growth Rate
- Looking for sustainable dividend growth

The first thing I look for in a company is a track record of consistently covered dividends. That’s a reasonable starting point, but like most income-focused investors I don’t just want dividends, I want dividend growth as well.

At the very least, some amount of dividend growth is necessary if only to keep up with inflation. In other words, if a company fails to grow its dividend faster than inflation over the medium-term, then the purchasing power of those dividends is actually falling.

## Measuring dividend growth

If we’re looking for dividend growth then it seems sensible to start by measuring the growth of a company’s dividend. And while I do measure dividend growth, that isn’t where I start.

To explain why, here’s a simplistic step-by-step example of how you might start a new business:

- You start a new company to build widgets.
- You fund the business by moving your life savings into its bank account.
- You use that money to buy the machines which will manufacture the widgets.
- You don’t have anywhere to put the machines so you rent (i.e. lease) a factory.
- You need more machines so you buy them using money borrowed from the bank.
- You buy raw materials which will be used to make widgets.
- You turn on the machines, feed in the raw materials and churn out widgets. Customers begin buying widgets and sending money into your company’s bank account.
- You use that money to pay your employees, suppliers, utility bills and so on.
- If there’s any money from customers left over at the end of the year then the company made a profit, so it has to pay tax.
- After making a profit and paying taxes then, and only then, can you realistically begin to think about paying yourself a dividend.

As you can see, there are many things which need to happen before dividends can be paid. Companies need to invest in assets such as factories, equipment and stock, they need to sell products or services to customers and they need to pay suppliers, employees and taxes. Dividends, if any are to be paid, come at the very end of that process.

So we have to measure growth across a range of these factors, otherwise we’re only getting half (or less) of the picture.

Before I get into the details, here’s some basic terminology (i.e. jargon) which you’ll need to know if you want to analyse businesses. If you already know these terms feel free to skip ahead.

Definitions

**Capital employed: **Companies need assets, such as factories, offices, machinery and raw materials to produce products and services for their customers. These assets are funded by a combination of equity capital, debt capital and leased capital, which together make up capital employed.

**Equity capital:** The amount of funding borrowed from (and owed to) shareholders. Usually it’s mostly made up of retained earnings (earnings which were not paid out as dividends) and funds raised directly from shareholders (e.g. through a rights issue where shareholders inject additional funds into a company in exchange for new shares).

You can find equity capital on the balance sheet where it’s known as shareholder equity or total equity.

**Debt capital:** The amount of cash funding borrowed from banks or other lenders.

You can find it on the balance sheet where it’s usually called borrowings, bank loans, overdrafts and so on.

**Leased capital: **The value of long-term capital assets (e.g. restaurants and retail stores) borrowed from leasors and landlords. Although leased capital comes in the form of rented machinery or property, a lease liability is just another form of debt, like borrowings owed to a bank.

Unfortunately, lease liabilities can sometimes be tricky to find.

After 2019 or so, you’ll usually find lease liabilities recorded on the balance sheet. This is a recent change thanks to a new accounting standard, IFRS 16. If you can’t find them on the balance sheet then you may have to search the annual report for “lease liabilities” to find the correct amount.

Before 2019, lease liabilities weren’t on the balance sheet. So for older annual reports, search for the “operating lease” section in the notes at the back of the annual report.

This may seem like a lot of work, but once you’ve done it a few times it’s fairly easy. And the information it gives you about a company and its profitability is well worth it.

**Revenues: **The amount of money earned by a company over a given period (e.g. six months for the interim results and 12 months for the annual results), before expenses. Also known as sales or turnover, you’ll find revenue at the top of the income statement.

In simple terms then, companies first grow their capital employed by raising additional equity, debt or leased capital to fund new factories, machines, stock and so on. Those assets then generate growing revenues, and hopefully those revenues will allow the company to grow its dividend.

**So the first thing I look for is capital employed growth, followed by revenue growth and then dividend growth.**

To keep things simple, I combine capital employed growth, revenue growth and dividend growth into into a single metric which I somewhat unimaginatively call **Growth Rate**.

## Calculating a company’s Growth Rate

The first thing to note is that growth should be measured over a period of at least a ten-years because measuring growth from one year to the next is a waste of time.

Even the best companies will occasionally shrink in a given year, just as the worst companies can grow in a single year. What matters then is not what happens in a single year, but what happens year after year after year, and perhaps even decade after decade.

My preferred approach to measuring long-term growth is one I borrowed from Benjamin Graham. The approach has two basic steps:

- Calculate multi-year averages for capital employed, revenue and dividends to smooth out the ups and downs of individual years
- Measure how those averages have changed across a ten-year period.

We’ll need capital employed, revenue and dividend data, all on a per share basis for the last ten years. You should already have the dividend data for your chosen company if you worked through the dividend cover calculations from the previous article.

Here’s a quick reminder of where to find the data in the company’s annual reports (or you could take the easier route and use a data provider such as Morningstar or SharePad):

**Capital employed**: On the balance sheet. It’s made up of:**Equity capital**: Called total equity, shareholder equity or net assets.**Debt capital**: Under liabilities, called borrowings, bank loans and overdrafts or similar.**Leased capital**: Usually called lease liabilities. If you can’t find it on the balance sheet search for “lease liabilities” or “operating lease” as it may not be listed as a separate item on the balance sheet.

**Revenue**: At the top of the income statement.**Dividends**: Usually mentioned near the start of the annual report and/or underneath the income statement.**Number of shares**: Usually mentioned in the accounting notes at the back of the annual report. Search for “weighted average” and you’ll see it mentioned in the calculation for earnings per share.

As an example of how to convert a total figure into a per share figure, here’s the calculation for revenue per share:

Revenue per share = revenue / average number of shares

Per share figures are usually quoted in pence, so you may want to multiply the resulting per share figure by 100 to convert it from pounds into pence (or the foreign currency equivalent).

This is of course much easier if you use a spreadsheet, and if you don’t want to make your own then you can use the same investment spreadsheet as I do.

Now that we have all the necessary data, the steps for calculating a company’s Growth Rate are as follows (don’t worry if these instructions are a bit dry and academic; we’ll work through an example soon enough):

Steps to calculate Growth Rate

**1) Calculate capital employed per share (CEPS) growth**:

1.1) Calculate CEPS for each of the last ten years.

1.2) Calculate the average CEPS for the oldest three years.

1.3) Calculate the average CEPS for the latest three years.

1.4) Calculate CEPS growth:

*CEPS* *growth = (latest avg. CEPS* */ oldest avg. CEPS* *) – 1 × 100%*

**2) Repeat step 1 for revenue per share (RPS)**

**3) Repeat step 1 for dividends per share (DPS)**

**4) Calculate growth as the average of CEPS, RPS and DPS growth:**

*growth = (CEPS growth + RPS growth +*

*DPS growth) / 3*

**5) Calculate the annualised growth rate:**

*Growth Rate = ((100% + growth) ^ 1/ 7) – 100%*

In the expression above, “^” is called a caret and it represents an exponential, in other words it means “raise to the power”. In this case we’re raising the total growth figure to the 1/7th power.

There are two reasons why we use the 1/7th power.

The first is that there are seven years between the oldest and latest three-year averages in a ten-year period.

The second is that the 1/7th power is effectively the opposite to the 7th power. If we wanted to calculate total growth over seven years at a given growth rate, we would raise that growth rate to the 7th power (i.e. multiply it by itself seven times). However, in our calculation we’re starting with the total growth rate and calculating the annual growth required to achieve that total growth, so it’s the opposite calculation which is why we use the opposite power (1/7th in this case).

This sounds more complicated than it actually is, and thankfully an investment spreadsheet can do all this in an instant.

I think now is a good time for an example; but first, here are the related rules of thumb:

Growth Rate rules of thumb

Only invest in a company if its Growth Rate was above inflation (approximately 2%).

Be wary of companies where capital employed, revenue or dividend per share growth over ten years was negative.

## Burberry’s Growth Rate

I’ll use Burberry as an example again, having already reviewed it briefly when we looked at the consistency of its dividend cover. The table below contains all the per share data we’ll need to calculate Burberry’s Growth Rate.

Year | Revenue PS (p) | Capital Employed PS (p) | Dividends PS (p) |
---|---|---|---|

2010 | 268.2 | 287.6 | 14.0 |

2011 | 338.1 | 319.1 | 20.0 |

2012 | 418.0 | 386.2 | 25.0 |

2013 | 447.6 | 404.9 | 29.0 |

2014 | 520.9 | 464.7 | 32.0 |

2015 | 563.5 | 546.9 | 35.2 |

2016 | 563.7 | 554.2 | 37.0 |

2017 | 625.5 | 596.3 | 38.9 |

2018 | 636.4 | 522.5 | 41.3 |

2019 | 655.3 | 586.2 | 42.5 |

**Burberry’s capital employed, revenue and dividends to 2019**

You can get a general feel for how fast Burberry grew over those ten years by looking at its 2019 figures compared to those from 2010. All of them have more than doubled in that time, so the company has definitely grown quite quickly.

However, it will be much easier to compare Burberry’s growth to other companies if the mass of figures in that table are first converted into a single Growth Rate using the steps outlined earlier:

Calculating Burberry’s Growth Rate

**1) Calculate capital employed per share (CEPS) growth:**

1.1) Calculate CEPS for each of the last ten years:

As an example, here’s the calculation for 2010:

Equity, borrowings, lease liabilities and number of shares for 2010 were £590.1 million, £206.4 million, £474.5 million and 441.9 million respectively, so:

*Capital employed = £590.1m + £206.4m + £474.5m = £1,271.0m*

*CEPS = £1271.0m / 441.9m = £2.876 = 287.6p*

1.2) Calculate average CEPS for oldest three years:

CEPS for 2010, 2011 and 2012 was 287.6p, 319.1p and 386.2p respectively, so:

*oldest avg. CEPS = (287.6p + 319.1p + 386.2p) / 3 = 331.0p*

1.3) Calculate average CEPS for latest three years:

CEPS for 2017, 2018 and 2019 was 596.3p, 522.5p and 586.2p respectively, so:

*latest avg. CEPS = (596.3p + 522.5p + 586.2p) / 3 = 568.3p*

1.4) Calculate CEPS growth:

*CEPS growth = (568.3p / 331.0p) – 1 = 0.717 = 71.7%*

**2) Calculate revenue per share (RPS) growth:**

2.1) Calculate RPS for each of the last ten years:

As an example, here’s the calculation for 2010:

Revenue and number of shares for 2010 were £1,185.1 million and 441.9 million respectively, so:

*RPS = £1185.1m / 441.9m = £2.682 = 268.2p*

2.2) Calculate the average RPS for the oldest three years:

RPS for 2010, 2011 and 2012 was 268.2p, 338.1p and 418.0p pence respectively, so:

*olde*st* a*vg. *RPS = (268.2p + 338.1p + 418.0p) / 3 = 341.4p*

2.3) Calculate the average RPS for the latest three years:

RPS for 2017, 2018 and 2019 was 625.5p, 636.4p and 655.3p respectively, so:

*latest avg. RPS = (625.5p + 636.4p + 655.3p) / 3 = 639.1p*

2.4) Calculate RPS growth:

*RPS growth = (639.1p / 341.4p) – 1 = 0.872 = 87.2%*

**3) Calculate dividend per share (DPS) growth:**

3.1) Calculate DPS for the last ten years:

DPS doesn’t need to be calculated as it’s usually quoted in each annual report.

3.2) Calculate the average DPS for oldest three years:

DPS for 2010, 2011 and 2012 was 14.0p, 20.0p and 25.0p respectively, so:

*oldest avg. DPS = (14.0p + 20.0p + 25.0p) / 3 = 19.7p*

3.3) Calculate average DPS for latest three years:

DPS for 2017, 2018 and 2019 was 38.9p, 41.3p and 42.5p respectively, so:

*latest avg. DPS = (38.9p + 41.3p + 42.5p) / 3 = 41.0p*

3.4) Calculate DPS growth:

*DPS growth = (41.0 / 19.7) – 1 = 1.080 = 108.0%*

**4) Calculate growth as the average of CEPS, RPS and DPS growth:**

*growth = ( 71.7% +*

*87.2% + 108.0%) / 3 = 89.0%*

**5) Calculate the annualised growth rate:**

*Growth Rate = ((100% + 89.0%) ^ 1/7) – 100% = 9.5% *

Burberry’s ten-year Growth Rate is 9.5% per year. That’s above my 2% rule of thumb, above inflation for the period and comfortably above the average growth rate of FTSE 350 companies.

Just as importantly, Burberry’s growth was broad based with capital employed growing by 72%, driving revenue growth of 87% which in turn allowed the dividend to be increased by 108%.

## Looking for sustainable dividend growth

Burberry’s rapid growth is a good start, but rapid growth which is sustainable is even better, so in the next article in this series I’ll outline how I look for sustainable dividend growth.

For now though, here’s a quick recap of my Growth Rate rules of thumb:

Growth Rate rules of thumb

Only invest in a company if its Growth Rate was above inflation (approximately 2%).

Be wary of companies where capital employed, revenue or dividend per share growth over ten years was negative.

If you’re wondering why I haven’t mentioned earnings or earnings growth, its because I don’t measure earnings growth directly. Instead, I look at earnings indirectly by measuring return on capital employed, return on sales and dividend cover. Return on capital employed and return on sales are important profitability metrics, and I’ll cover them in more detail in a future article.

I am using only “sales” for my growth factor, not “capital employed” or “dividends”.

I disregard “capital employed” because the figures in the accounts are not representative of the real world replacement value. The influence for my decision is the CROCI book by Pascal Costantini.

Accounting of intangible assets is inconsistent, such as the expensing of R&D. In the book he adjusts “capital employed” but it requires painstaking research per company, so I’m relying on “sales” instead. Including the leased assets certainly helps close the gap.

I’m hoping that “sales” are honest numbers. I am aware of manipulation such as “channel stuffing” but I hope that evens out over a decade, unless the manipulation is only in the last year (the tide may be out this year).

As for “dividends”, they are not explicitly included in any of my calculations (perhaps our Dividend Hunter thinks I’m posting on the wrong forum). I consider the dividends as a component of FCF.

I’m using these wacky ideas to allocate my life savings, slowly, one purchase per month, so I am genuinely open to constructive criticism.

I use as many years of data as SharePad provides (up to 11 years can be exported) and my average is weighted so the “drop off” of the oldest year is insignificant. This weighting is potentially a disaster for cyclicals.

Hi Ken, some interesting points there and a very cautious approach it seems. I don’t have any strong opinions on the issues you’ve mentioned, although I do think the CROCI approach seems sensible enough.

Hi,

Just wanted to reach out and say hello!

Quality content you are putting out. I have been investing around 8 months now, starting with Vanguard ETFs but now on a dividend growth strategy with Trading 212.

Growing and learning everyday. Your blog among others helps! I even setup my own blog as a way of helping new investors more easily digestion some of the heavier information.

Keep doing what you are doing!

Thanks,

Sean C

Thanks Sean, it’s good to see another investment/finance blog with a UK focus.

Hi John,

Over the months I’ve began to simplify my investment process. Once upon a time I had so many financial ratio’s that if I came back to the spreadsheet one week later I wouldn’t be able to explain myself what the spreadsheet was saying about a potential company. That was quite embarrassing if you ask me.

I now use two key yardsticks:

Return on Tangible Equity – if a company generates a substantial return on its physical assets it implies that the company has substantial goodwill value and more importantly a moat. A good example is VISA or MasterCard.

Owners Earnings – an idea Buffett developed this looks at how much cash is left after both working capital and capital expenditure are accounted for. Netflix is a good example where despite having a high return on tangible equity being a platform business it fails on owners earnings because of the need to constantly to create new content means it burns through more cash then it generates in the business.

The return on tangible equity can be derived from the balance sheet whilst I use cash flow statement to get an approximation of owners earnings. Suffice to say I can now look at a spread sheet a few months later and understand the financials without being extremely confused.

Hi Reg

Simplicity is something I’ve had to work on too, but I think it’s worth it. Like you, I found it tempting to add 101 ratios for this, that and everything else, but all that does is create noise. I’m not quite down to your two key metrics, but I do focus on:

long-term growth rate

long-term growth consistency and sustainability

profitability (primarily return on capital employed)

leverage (debt and equity relative to earnings)

capital intensity

acquisitiveness

Those are the key financial metrics, and then of course you have to do some analysis of what the company does, its market and so on. Very briefly, my qualitative key metrics are probably:

a focused core business

market leadership

a growing core market

opportunities for moves into adjacent markets (geographical, customer segment, up and down the value chain, etc)

So there are still a lot of moving parts, but there should probably only be a handful of key factors which you should be able to describe in an “elevator pitch” single sentence.

Hi John,

I’m not sure if you read any of the works by Michael Porter but I use a lot of his ideas to analyse a company on a qualitative basis.

I think people fail to appreciate the importance of qualitative analysis because its not something you can allocate neatly within a spreadsheet. This why I had to simply my quantitative analysis because its extremely difficult to make accurate financial forecasts and as you say the 101 ratios just create endless noise.

However it’s much easier to make a binary estimation for certain sectors whether the product will remain in existence and how much competition you are likely to have. Questions like these can be universally applied to any business. The only thing is as an investor you need to be confident that you understand the business well enough to make accurate assumptions.

I think modern day investors are blessed with so much useful information which they never seem to make good use of such as old interviews by business leaders on YouTube. You can learn so much in a half an hour interview with Bill Gates from the 90s about business than a 500 page investing book.

Although I do think your article does a good job in summarising the essentials I think its taken me a long time for these facts to soak into my head.

Hi Reg, the business analysis is by far the most interesting bit anyway. The number crunching is just there to make sure you’re fishing where the fish are, i.e. only looking at companies with attractive profitability, growth etc, but the devil is in the details and the details reside in the business model.

John, could you explain the need for “details” and “analysis” in comparison to Joel Greenblatt’s Magic Formula, which deliberately omits stock specific details.

If we mechanically allocate money according to quantitative factors (simple) then what is the downfall? (e.g. Patisserie Valerie, Carillion)

If we have discretion to meddle (qualitative) this has been shown to undermine the strength of blindly following a set of rules (I’m referring to studies where medical experts underperform).

Reg, thank you for sharing your two ratios.

What are the inputs of second ratio?

FCF or FCF?

EV or MarkCap?

Hi Ken,

I refrain from using ratios because of the confusion it can create. I guess what I do is merely basic accounting.

The first thing I do is include only companies where what they earn on the P/L statement is reflected on the Cash Flow statement or near enough. This process excludes a lot of companies. Owners earning won’t work if earnings and cash flow don’t match near enough. Often it can be tell tale sign of a fraudulent company if what they report in earnings doesn’t translate into cold cash.

Using the operating cash flow you simply subtract working capital which is business expense and cost of goods/service. Followed by this you look at how much a company is investing to replace depleted fixed assets this can be both tangible (property, plant or equipment) or intangible assets (acquiring brands, R&D, software and etc). The other reason for investing in fixed asset is because the company management is confident it will grow like Jeff Bezos did with Amazon pretty much since it was created.

Two things I look at from owners earnings (1) is there any spare cash left and (2) I look at returns on equity. Obviously if a company has no money left to spare that’s always a bad sign. If spare cash is left you need to look at returns on equity to help evaluate whether capital expenditure is providing a good return.

If a company fails to provide a decent return on the money they have invested in fixed assets as an investor I ask myself whether they are wasting the money of the shareholder or its a mere reflection of the industry the company operates in.

This is a very simplified version of the concept in my head. Qualitative data is the main drive for making this work because it really depends on how well as an investor you understand a business. One thing I have started to realise is that for quality companies they don’t payout much of their earnings because the management create better shareholder value by reinvesting this capital within the business. This is why owners earnings is a useful tool to see how much spare cash they make and if the returns on equity is respectable for those companies which prefer to reinvest it into the business.