In hopes of getting better numbers to project off of, I've been compiling data to calculate the dividend growth rate of my entire portfolio. Easy right? Just add up the dividend growth rate for each position and divide by the total number of positions. Well, that's not quite right because each position is a different size and therefore contributes a different amount to the overall dividend growth. A 10% position of your portfolio growing the dividend at 20% per year changes your dividends received a lot more than a 1% position growing the dividend at 20% per year. So how do you calculate it then?

In order to calculate the overall dividend growth rate you have to take a weighted average. Per Investopedia, a weighted average is "an average in which each quantity to be averaged is assigned a weight. These weightings determine the relative importance of each quantity on the average. Weightings are the equivalent of having that many like items with the same value involved in the average." Essentially you're assigning a weight to each position, in this case that would be the weighting of your portfolio. You then multiply the weight by the dividend growth rate of your choice, 1 year, 3 year, 5 year, 10 year, since the start of the dividend being increased. Whatever you choose.

The formula works out as (DG1 * MV1 + DG2 * MV2 + DG3 * MV3 + DGn * MVn) / (M1 + M2 + M3 + Mn), where DGn = the dividend growth rate of position n and MVn = market value of position n. If you go through the math, this is equivalent to DG1 * W1 + DG2 * W2 + DG3 * W3 + DGn * Wn, where Wn = the weighting of position n in the whole portfolio or MVn / Total Portfolio Value.

Luckily with spreadsheets it's very easy to calculate this. In Excel or Google Spreadsheet you use the =sumproduct(range of cells for weight, range of cells for growth rate) or if you want to do it the other way you can use =sumproduct(range of cells for market value, range of cells for growth rate) / sum(range of cells for market value). I find it easiest to just use the weighting that I've already got calculated in my portfolio spreadsheet. In my spreadsheet, my formula looks like this = sumproduct(B3:B25,C3:C25) that's the formula in C27 next to Weighted Average Growth Rate.

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You can take it a step further by weighting the dividend growth rates if you so choose. For example, say you have the 1 year, 3 year, 5 year and 10 year dividend growth rates for each company that you own. You could weight them to give the longer dividend growth rates more value than the shorter growth rates. To calculate that I would use take each of the dividend growth rates and multiply them by their corresponding weights. For the weights, I would use 1 + 3 + 5 + 10 = 19 as my total and the 1 year growth rate by 1/19, the 3 year growth rate by 3/19, the 5 year growth rate by 5/19 and the 10 year growth rate by 10/19. The weighted average dividend growth rate for that company is simply the sum of all of those. For example, say a company has a 1 year growth rate of 5%, 3 year growth rate of 8%, 5 year growth rate of 10% and 10 year growth rate of 12%. The weighted average would be 0.05 * 1/19 + 0.08 * 3/19 + 0.10 * 5/19 + 0.12 * 10/19 = 10.47%.

Personally I'd make a change to the weights and reverse the weights. So the 1 year growth rate weight becomes 10/19, 3 year growth rate becomes 5/19, 5 year growth rate becomes 3/19 and the 10 year growth rate becomes 1/19. The reason I prefer to do it this way is because over a 10 year period a company will have experienced quite a bit of growth in revenue, earnings and dividends per share. If the dividend growth rate has exceeded the earnings per share growth rate then the payout ratio has increased. This could lead to slower dividend growth going forward, so I would want to place more weight on the more recent dividend growth rates. Using the same values for the growth rates as above, but reversing the weights gives a weighted average dividend growth rate of 6.95%.

You would then go through this same process of weighting the dividend growth rates for each position and repeat the previous steps to calculate the overall weighted dividend growth rate for your portfolio. Calculating a weighted average dividend growth rate for you entire portfolio is good to know because it lets you see just how much organic growth in your dividends you can expect to receive. This allows for better projections of future dividends which makes it a lot easier to project when your dividend income might be able to surpass your expenses, meaning you're reached financial independence.

The equation becomes much simpler if you are taking the dividends as cash, i.e. not reinvesting the dividends at all, and are not adding any fresh capital to the portfolio. In that case the easiest way to calculate the overall dividend growth rate is to divide the current year's dividends by the previous year's dividends and subtracting 1 to get the growth rate. For example, 2012 Dividends / 2011 Dividends - 1 = Year over Year Dividend Growth Rate.

In the above spreadsheet I'm calculating a weighted 1 year, 3 year, 5 year and 10 year growth rate as well as a overall weighted dividend growth rate using the reversed weights from above. Some calculations are different since not all positions (KMI, PM, PSX) have even been around for 10 years. I'm happy to see a 11%+ overall dividend growth rate for my FI portfolio and 20%+ for my Roth IRA, although I fully expect the Roth growth rate to come down from its current lofty levels.

Be careful in projecting elevated growth rates very far into the future because it will overestimate the actual growth and you will be quite disappointed by the results. I used a 5% dividend growth rate for my projections for reaching FI, but using the weighted average growth rate from my calculations would mean I would hit FI a full 5 years earlier while keeping everything else the same. I'd much rather be conservative in my assumptions and be pleasantly surprised than too aggressive and be disappointed.

*Thanks to All About Interest for showing me the error of my ways. Instead of calculating based off the portfolio weight, it should be calculated on the dividend weight. Dividend weight is the forward dividends for each position divided by the total forward dividends of the portfolio. The weighting process remains the same.

If the calculations show zeroes, it's because by running through Google spreadsheets/drive and linking to other spreadsheets, the update isn't as automatic like when it's just on your own computer. It should come up if you give it a few minutes.

ReplyDeleteYeah, it never worked for me embedded in the webpage. I had to click on the full-page view and then refresh before the calcs worked properly.

DeleteNice work!

Executioner,

DeleteIt works some of the time. But I think the issue is that it's linking to another spreadsheet, that is then pulling the latest prices using the GoogleFinance function, so there's a lag. I noticed the Roth IRA tab seemed to come up much faster, probably because it's pulling much less information.

Glad you enjoyed it and I hope it can help you out. I'm working on creating a useful spreadsheets link on my page where you can put in the required inputs and the spreadsheets will calculate everything for you. Just trying to help anyone out in case they are math inclined.

Thanks for stopping by!

I tried and it didn't show up on your FI portfolio. Only on your IRA the page loaded with data.

ReplyDeleteand to add to it, it is nice work. I think I will add similar analytics to my own spreadsheets too. Thx for sharing.

ReplyDeleteMartin,

DeleteI think it's just a lot of information being pulled, bc the IRA one usually pulls up and it's smaller. I like it because it makes it easier to see overall what your dividend growth rate is. When you're adding new capital it makes it too hard to see what the actual increases were just from dividend growth. Hope it helps you out. I'm working on getting some spreadsheets put on my blogroll page to help others out, especially those that might not be that math oriented or are new to investing and considering starting down a DG path.

Thanks for stopping by!

It would be nice if you would share your spreadsheets. Currently I myself am not watching the growth, just simple annual dividend received or planned to receive and based on that I watch the % of income of my portfolio. Based on that I am weighting my allocation. That means that I try to have my stock allocation equal per income rather than stock weight. In case the stock decreases or ceases paying the dividend, I know what income I lose. For example if all my stocks are allocated so all dividends income for each stock is 4% of the entire portfolio, you risk 4% only. If you allocate based on price, some stocks can bring you 20% of the entire income and others only 3% of the income. If the stock, which is bringing 20% of the entire income cuts the dividend, you suddenly lose 20% of the entire income.

DeleteI will be thinking about how I can use weighted growth rate to my benefit, but I feel that in the light of above approach, it my also be beneficial to me.

Funny you should mention saying my spreadsheets. I've been working on getting some loaded. There's only 2 right now, the links are at the bottom of my blogroll page, but more will be coming once I can get them on there. Can you save the spreadsheet or no? If not then I'll see if I can change the sharing on it.

ReplyDeleteI was reading an article earlier this week talking about weighting you're portfolio. But it wasn't necessarily for dividend learned investors. Eventually I'd like to have it weighted more based on income butt I'm very early in the accumulation phase so I'm not too worried about it yet. I think knowing the overall growth rate for the portfolio is useful. Plus you can compare the companies side by side in my spreadsheet. When you're in the accumulation phase its easy to see your total dividends increase by a significant amount mainly from additional capital that you don't check the actual growth numbers.

Thanks for stopping by!

Sorry for the typos. Aurocorrect on the smart phone apparently isnt that smart. I'll work on the spreadsheets though over the next week.

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ReplyDeleteThis is my first time i visit here. I found so many entertaining stuff in your blog, especially its discussion. From the tons of comments on your articles

ReplyDelete