Retention Ratio

AAA

DEFINITION of 'Retention Ratio'

The proportion of earnings kept back in the business as retained earnings. The retention ratio refers to the percentage of net income that is retained to grow the business, rather than being paid out as dividends. It is the opposite of the payout ratio, which measures the percentage of earnings paid out to shareholders as dividends.

On a per-share basis, the retention ratio can be expressed as (1 – Dividends per share / EPS).

retention ratio formula                                                                    

 

The retention ratio is 100% for companies that do not pay dividends, and is zero for companies that pay out their entire net income as dividends.

Also known as “plowback ratio.”

INVESTOPEDIA EXPLAINS 'Retention Ratio'

For example, a company that has EPS of $1.00, and per-share dividends of $0.40, has a dividend payout ratio of 40%, and a retention ratio of 60%.

The retention ratio is typically higher for growth companies that are experiencing rapid increases in revenues and profits. A growth company would prefer to plow earnings back into its business if it believes that it can reward its shareholders by increasing revenues and profits at a faster pace than shareholders could achieve by investing their dividend receipts.

Investors may be willing to forego dividends if a firm has great growth prospects, which is typically the case with companies in sectors such as technology and biotechnology. The retention rate for technology companies in a relatively early stage of development is generally 100%, as they seldom pay dividends. But in mature sectors such as utilities and telecommunications, where investors expect a reasonable dividend, the retention ratio is typically quite low because of the high dividend payout ratio.

The retention ratio may change from one year to the next, depending on the company’s earnings volatility and dividend payment policy. Many blue-chip companies have a policy of paying steadily increasing or at least stable dividends. Companies in defensive sectors such as pharmaceuticals and consumer staples are likely to have more stable payout and retention ratios than energy and commodity companies, whose earnings are more cyclical.

Dividend-paying stocks became all the rage in the low interest-rate environment that prevailed post-recession 2008-09. As an increasing number of companies – even those in sectors that had hitherto not paid dividends, such as gold producers – began  paying dividends, their retention rates declined, as investors focused on current income rather than the promise of (higher) potential income down the road.

VIDEO

Loading the player...
RELATED TERMS
  1. Dividend

    A distribution of a portion of a company's earnings, decided ...
  2. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  3. Payout Ratio

    The proportion of earnings paid out as dividends to shareholders, ...
  4. Dividend Aristocrat

    A company that has continuously increased the amount of dividends ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in ...
  6. Income Stock

    An equity security that pays regular, often steadily increasing ...
RELATED FAQS
  1. How does the bottom line affect shareholder returns?

    The bottom line directly relates to how much a company is able to pay out in dividends to shareholders over a specified time ... Read Full Answer >>
  2. How do I calculate the dividend payout ratio from an income statement?

    A company's dividend payout ratio is easily calculated using the figures found at the bottom of its income statement. The ... Read Full Answer >>
  3. How do you calculate the geometric mean to assess portfolio performance?

    The geometric mean is used to calculate the central tendency of a set of numbers. It is the average of the logarithmic values ... Read Full Answer >>
  4. What does the operating cash flow ratio measure?

    The operating cash flow ratio measures a company's ability to meet its short-term, or current, liabilities, also known as ... Read Full Answer >>
  5. What's the difference between the coverage ratio and the levered free cash flow to ...

    Coverage ratios focus on a company’s ability to manage its debt, while the levered free cash flow to enterprise value ratio ... Read Full Answer >>
  6. What are some ways a company can improve on its Return on Capital Employed (ROCE)?

    Options available to a company seeking to improve on its return on capital employed (ROCE) ratio include reducing costs, ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Lessons On Corporate Dividend Payout And Retention Ratio

    Why are dividend payout and retention ratios important to consider when investing in company stock? What companies have high ratios?What constitutes a high dividend payout and retention ratio? ...
  2. Investing Basics

    How And Why Do Companies Pay Dividends?

    If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments ...
  3. Investing Basics

    Income, Value and Growth Stocks

    Investors who buy stocks generally seek one of three criteria: undervalued holdings, growth potential or steady income. The characteristics of stocks in each of these categories differs accordingly.
  4. Investing Basics

    Don't Take Dividends For Granted

    Companies have been paying dividends to their shareholders since the 1600s and have given investors good reason to hold onto their shares for long time periods. For many investors, dividends ...
  5. Trading Strategies

    Introduction To Dividends

    Investing in dividend-paying stocks can be an effective method of building long-term wealth.
  6. Fundamental Analysis

    Evaluating Retained Earnings: What Gets Kept Counts

    A company's retained earnings matter. Be investment-savvy and learn how to analyze this often overlooked information.
  7. Investing Basics

    What Dividends Say About Stock Health

    Dividend payments may reveal information about the future prospects of a company.
  8. Options & Futures

    Dividends, Interest Rates And Their Effect On Stock Options

    Learn how analyzing these variables are crucial to knowing when to exercise early.
  9. Markets

    Your Dividend Payout: Can You Count On It?

    We go over several telling factors that can help you answer this question and avoid losses.
  10. Investing

    Why International Diversification Matters Today

    Given the breadth and diversity of the U.S. economy and market, many U.S. investors feel comfortable keeping their money within U.S. borders.

You May Also Like

Hot Definitions
  1. Fisher Effect

    An economic theory proposed by economist Irving Fisher that describes the relationship between inflation and both real and ...
  2. Fiduciary

    1. A person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets ...
  3. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  4. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  5. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  6. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
Trading Center