When investors consider buying an ASX share to add to their portfolios, they can examine countless metrics and ratios to determine whether or not it is a good idea.
There's the universally popular price-to-earnings (P/E) ratio, of course. But there's also the price-to-book (P/B), price-to-sales (P/S), and price/earnings-to-growth (PEG) ratios.
One could also analyse a company's revenue numbers and growth trajectory, as well as its earnings, free cash flow, and profits.
All of these metrics are useful in their own way. But this is one number that I always look at when evaluating a business' inherent quality and determining whether it is an ASX share worth buying. This metric, I believe, tells us far more about a company's financial strength and future growth prospects than any other single number.
It is an ASX share's dividend growth rate.
What does a dividend growth rate tell us?
The vast majority of the ASX shares listed on our market pay dividends.
Most investors would know that a dividend is a payment made to the shareholders of a company as an incentive or reward of sorts for owning said company's shares.
But what many investors might not realise is that paying dividends fundamentally weakens a company. When a company chooses to pay out a dividend, it is essentially giving that money away, never to return. That money could otherwise be used to pay down debt, invest in future growth, or earn interest in the bank.
Only the best companies can afford to pay a consistent dividend that rises over time. And only the best of the best have the ability to consistently raise this dividend by meaningful amounts every year.
Companies can do all sorts of accounting magic when reporting their earnings to make the numbers look better. That's why some businesses report pure earnings, but others report earnings before interest, tax, depreciation and amortisation (EBITDA), earnings before significant items, or perhaps just earnings before interest and tax (EBIT).
But what a company can't fudge is its dividend history.
If you find a share that has paid a consistently rising dividend for more than five years and has increased by more than the rate of inflation, chances are it is a high-quality business that beats the market.
ASX shares with high dividend growth rates
Washingon H. Soul Pattinson and Co Ltd (ASX: SOL)? You bet. Soul Patts has increased its annual dividend like clockwork every single year since 2000. Between FY2021 and FY2024, investors enjoyed a compounded annual dividend growth rate of 15.3% per annum.
As such, it shouldn't come as a surprise to hear that Soul Patts has smashed the market over the past 20 years.
It's a similar story with TechnologyOne Ltd (ASX: TNE). TechnologyOne has grown its annual dividend by a compounded 15% per annum between FY2020 and FY2024. The company has also paid a dividend every year since 1996. However, even after this blistering income growth, it still only paid out 62% of its earnings as dividends in FY2024.
This tells me that Technology One is a compounding machine that can afford to grow its business and fund an ever-rising dividend.
WiseTech Global Ltd (ASX: WTC) also fits the bill, recent CEO antics aside. It has paid a fairly consistent dividend since 2017 and grew its annual payouts from 3.3 cents per share in 2020 to 16.9 cents per share in 2024. That's a four-year compounded annual dividend growth rate of over 50%.
In the United States, some of the market's best long-term performers also have the best dividend growth rates. That includes everything from Coca-Cola and Mastercard to Altria and Apple.
Of course, this metric isn't the be-all-and-end-all, pass-fail check for buying ASX shares. Just this morning, I wrote about how other issues at Wisetech have stayed my hand from buying this company.
Even so, I don't think any other single metric is as useful as a company's dividend growth rate for assessing a company's inherent quality as an investment.
