What Are Return on Retained Earnings (RORE)?
Return on retained earnings (RORE) is a calculation that shows how well a company's profits, after dividend payments, are reinvested and is an indicator of its growth potential.
Understanding Return on Retained Earnings (RORE)
Return on retained earnings—the amount of money that is retained for future growth—reveals a lot about a company’s efficiency and growth potential. A high RORE indicates that it should reinvest in the business. A low RORE suggests that it should distribute profits to shareholders by paying out dividends if it cannot work out how to make an adequate return by growing the business.
As a company progresses through its industry life cycle, RORE will tend to fall. In this sense, RORE is related to the retention ratio, also known as the "plowback ratio," which measures what percentage of earnings is retained. Both measures are most useful when comparing firms in the same industry or sector.
A company’s ability to grow dividends is determined by what fraction of earnings is put back into the firm and how profitably those earnings are used.
There are a few different ways to arrive at the return on retained earnings. The simplest way to calculate it is by using published information on earnings per share (EPS) over a period of your choosing:
- Return on retained earnings = (most recent EPS - first period EPS) / (cumulative EPS for the period - cumulative dividends paid for the period)
Investors are looking for companies that make lots of money because of their premium business models, rather than companies that have to plow money back into the company just to stay competitive. Just as younger, fast-growing (expanding) companies will tend to have higher RORE, they also tend to have high retention rations.
Mature businesses, which tend to have lower returns on retained earnings, will tend to return more of their profit to shareholders. Blue-chip companies often have a policy of paying high and steady dividends—even if their earnings are cyclical.
RORE can also indicate how much a company’s retained earnings have contributed to an increase in the stock’s market price over time. A stock with steady growth will generate more earnings year after year with the money they have held back from shareholders.