The retention ratio is the percentage of earnings that companies keep rather than paying them out in dividends. Compared to the dividend payout ratio, the retention rate is the inverse. This ratio is used to measure a company’s ability to retain its earnings, a vital aspect for growth and potential capital gain. To calculate the retention ratio, a company must look at both the growth potential and the profitability of its operations. However, a low retention ratio can be a red flag for investors.
Low retention ratio
The retention ratio is a metric for companies that have retained earnings throughout the period. In other words, the earnings retained by a company over a period equal the total dividend funds and earnings for that interval. Although a high retention ratio can be a good sign, it is not always desirable from an investor’s standpoint. A company with a low retention ratio may be a growth stock but does not pay many dividends. As such, the investors should be aware of the industry and company’s performance before investing in a stock.
Positive sign of rational management
Retention ratio, also known as plowback, is a measure of a company’s ability to retain profits. Retention of profits indicates rational management that makes decisions based on the best interests of the shareholders. Typically, mature companies with large cash reserves are lower on the retention ratio. These companies are often called “cash cows.”
Sign of growth potential
High retention ratio indicates favorable economic conditions and business management is focusing on growth. Low retention ratio suggests low growth potential and lower satisfaction with current cash holdings. The retention ratio is often used in conjunction with other metrics, such as return on investment (ROI), to calculate sustainable growth. While retention ratios alone don’t tell the entire story, they can be helpful in assessing the health of a company. Let’s explore why retention ratios matter.
Sign of potential capital gain
Retention ratio is one of the key metrics for determining the profitability of a company. In general, a higher retention ratio indicates that the company isn’t paying out many dividends, but instead, the stock price is rising because of the company’s growth prospects. The ratio helps differentiate between growth stock and earnings stock. In this article, we’ll discuss how to determine a retention ratio and what it means to a company.
Formulas for calculating retention ratio
Retention ratio is a financial measure of a company’s ability to keep its existing shareholders. The ratio can be calculated as a percentage of net income or as a percentage of retained earnings. A company’s retention rate can also be calculated per share. For example, if a company has $100 million in revenue, and pays out $1 million in dividends each year, its retention ratio would be 76 percent.