Fine tune your dividend growth estimate with past growth rates
By now, you should have an understanding of how I calculated Caterpillar Inc. (NYSE:CAT)’s annual dividend growth estimate of 7.9% to 17%. This is a pretty big range, however, so I like to look at past dividend growth to try and come up with a better estimate. The most recent dividend increase was 15.4%, which is quite a bit higher than past averages.
Large increases are an indication from management that they expect good things in the future. Management doesn’t like to increase dividends beyond sustainable levels, because dividend cuts are viewed very negatively by shareholders. In Caterpillar Inc. (NYSE:CAT)’s case, the recent large increase is a good signal from management that they like the prospects of the company. With this in mind, I can now guess that dividend growth will be at the higher end of the 7.9% to 17% range, say around 15% annually.
Potential difficulties
When you don’t have a public dividend policy, the first step is usually trying to figure out the company’s target payout ratio by looking at its history. In some cases, the company may have recently changed its dividend policy, so historic payout ratio averages aren’t useful anymore. I’ll use Suncor Energy Inc. (USA) (NYSE:SU) as an example.
From 2003 to 2012, Suncor Energy Inc. (USA) (NYSE:SU)’s payout ratio was generally between 5% and 30%. From 2009 to 2012, it was generally around 20% to 30%. You might think that a reasonable estimate going forward would be 20%-30%, but with Suncor Energy Inc. (USA) (NYSE:SU)’s recent large dividend increase of 54%, it becomes harder to guess.
Over the past 10 years, dividend increases were generally around 20% annually, so 54% is unusually large. This could be a sign from management that they are planning on paying out a larger portion of their earnings as dividends. In these types of situations, it is harder to estimate future dividend growth because of the changing dividend policy.
Bottom line
Estimating five years out is difficult and analysts are thought to be right about 50% of the time, so it is important to take these estimates with a grain of salt. While no one can predict the future, I still like to try and guess the dividend growth, because it forces me to see if dividend growth is sustainable. While the process may not be perfect, it makes identifying good dividend growth candidates a lot easier.
The article How to Estimate Future Dividend Growth originally appeared on Fool.com and is written by Michael Weber.
Michael Weber owns shares of Suncor Energy (USA) and TELUS (USA). The Motley Fool has no position in any of the stocks mentioned. Michael is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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