Difference Between Dividend Growth and Dividend Mutual Fund

Key Difference – Dividend Growth vs Dividend Mutual Fund
 

The key difference between dividend growth and dividend mutual fund is that dividend growth rate is the annual percentage growth rate that a particular stock’s dividend undergoes over a period of time whereas dividend mutual funds are stock mutual funds that invest in companies that pay dividends. Dividend growth is an important aspect considered by shareholders where they are willing to see an upward trend in dividend growth. Dividend mutual funds have gained increased popularity as an investment option during recent times.

CONTENTS
1. Overview and Key Difference
2. What is Dividend Growth
3. What is Dividend Mutual Fund
4. Side by Side Comparison – Dividend Growth vs Dividend Mutual Fund
5. Summary

What is Dividend Growth?

Dividend growth rate is the annual percentage growth rate that a particular stock’s dividend undergoes over a period of time. Dividend growth is an important element that shareholders are concerned about. The ability of a company to pay a steady dividend is an indication that the company is profitable. Further, many investors prefer to receive a dividend as a stable income stream. For this reason, companies attempt to maintain a stable and upward trend in dividend payments.

Dividend growth is calculated using the ‘dividend growth model’ which is also called the ‘dividend discount model’ (DDM). This model calculates the value of a stock exclusive of current market conditions.

Price of stock = D₁ /r-g

D₁ = Expected dividend in year 1

r = Rate of return required

g = Expected dividend growth rate

E.g. BCD Company expects to pay a dividend per share of $0.80 for the next financial year. This dividend is expected to grow by 5% per year thereafter. Shareholders expect a rate of return of 7% from the stock of BCD. The price of BCD’s stock is,

Price of stock = $0.80/ (7%-5%)
= $40

Since dividend growth model facilitates the calculation of the value of a stock without the effect of current market conditions, this is a very useful tool for investors to compare stocks across companies and industries. However, there are two main assumptions in this model:

• Dividend growth rate (g) is constant, which may not be correct always.

• Dividend growth rate (g) cannot exceed the required rate of return (r). If g is greater than r, this indicates that the stock has a negative value, which is incorrect.
  

  Figure 01: Companies attempt to maintain an upward trend in dividend growth

What is Dividend Mutual Fund?

Dividend mutual funds are stock mutual funds that invest in companies that pay dividends. Dividend mutual funds are an attractive investment option for investors who prefer to receive a steady source of income. Further, they usually generate a higher rate of return compared to many other investment options such as bond finance.

Investment in dividend mutual funds is subjected to a minimum investment requirement amount and should be stated in the prospectus, which is a legal document that includes the details of the fund. Mostly, due to their income generating nature, dividend mutual funds are best-suited for retired investors. Dividend mutual funds are less risky investment options compared to other types of funds, such as growth stock mutual funds. Returns of dividend mutual funds are taxed as ordinary income. However, if the investor purchases dividend mutual funds in an Individual Retirement Account (IRA) (an investment option where a lump sum of funds is invested and withdrawals are made on completion of a specific time period), the tax will be deferred until the withdrawals begin.

What is the difference between Dividend Growth and Dividend Mutual Fund?

Dividend Growth vs Dividend Mutual Fund
Dividend growth rate is the annual percentage growth rate that a particular stock’s dividend undergoes over a period of time.	Dividend mutual funds are stock mutual funds that invest in companies that pay dividends.
Nature
Dividend growth is an indication of financial robustness of a company.	Investing in dividend mutual funds is a relatively less risky strategy that provides a steady income stream.
Taxation
Growth in dividends is taxable as ordinary income, resulting in higher taxes when the growth is high.	Tax is deferred for a certain time period in selected dividend mutual funds such as in Individual Retirement Funds.

Summary- Dividend Growth vs Dividend Mutual Fund

The difference between dividend growth and dividend mutual fund is a distinct one where dividend growth is the annual percentage growth rate that a particular stock’s dividend undergoes over a period of time while dividend mutual funds are stock mutual funds that invest in companies that pay dividends. Dividend growth model is a useful investment analysis tool that assists investors to compare investment options. Investors who prefer low risky steady income stream can benefit from investing in dividend mutual funds.

References:
1. “Gordon Growth Model.” Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail. N.p., n.d. Web. 10 Apr. 2017.
2. “Dividend Growth Rate: Everything You Need to Know.” Wyatt Investment Research. N.p., n.d. Web. 12 Apr. 2017.
3. Thune, Kent. “Learn How and Why to Invest in Dividend Funds.” The Balance. N.p., n.d. Web. 10 Apr. 2017.

Image Courtesy:
1. “Capital Structure Substitution – Dividend Policy” By Jonruse15 – Spreadsheet (CC BY-SA 4.0) via Commons Wikimedia