Retention Ratio Formula

• Retention Ratio Formula
• Retention Ratio Calculator
• Retention Ratio Template

Retention ratio formula indicates the percentage of a company’s earnings which is not paid out as dividends but credited back as retained earnings.

Retention Ratio Formula

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Examples of Retention Ratio Formula

Let us look into some of the examples for easier understanding:

Assuming Company ‘Z’ reported earnings per share of $100 and decided to pay $5 in dividends. With the above formula, the Dividend payout ratio is: $5 / $100 = 20%

This means Company ‘Z’ distributed 20% of its income in dividends and re-invested the rest back in the company i.e. 80% of the money was plowed back in the company. Thus,

Retention = 1 – ($2 / $10) = 1- 0.20 = 0.80 = 80%

Below is another example taking a comparison of 2 companies for improved understanding:

Retention for Firm ‘X’ = [Dividend / EPS] = $4.0 / $8.5 = 47.05%

Retention or Firm ‘Y’ = $3.0 / $10.5 = 28.57%

The plowback ratio of Company ‘X’ suggests that they have been struggling to find any profitable opportunities. Perhaps, the firm does not have many opportunities at the moment and thus will be distributing a reasonable portion of their earnings as dividends. This could also be a temporary tactic to keep a current lot of shareholders satisfied and enhance stock price for the immediate future.

With respect to Company ‘Y’, a lower retention and negative cash flows highlight the fact that they have been heavily investing in futuristic projects and perhaps may have retained sufficient earnings for future opportunities.

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Explanation of Retention Ratio Formula

This ratio highlights how much of the profit is being retained as profits towards the development of the firm and how much is getting distributed as dividends to the shareholders.

The size of the plowback ratio will attract different types of customers/investors.

• Investors which are income-oriented would expect a lower plowback ratio, as this suggests high dividend possibilities to the shareholders.
• Growth-oriented investors will prefer a high plowback ratio implying that the business/firm has profitable internal usage of its earnings. This, in turn, would push up the stock prices.

If the plowback ratio is close to 0%, there is a greater possibility of the firm being unable to maintain the existing levels of dividends distributed since it is distributing all returns back to the investors. Thus, sufficient cash is not available to support the capital requirements of the business.

We see that Amazon and Google have a retention of 100% (they retain 100% of profit for reinvestments), whereas, Colgate’s ratio is 38.22% in 2016.

Use of Retention Ratio Formula

Some of the uses of Retention Ratio Formula:

• It is very easy to calculate and suitable for a ball-park comparison amongst firms/sectors.
• The ratio can work in tandem with the dividend payout ratio to plan the future ideas of the firm.

Retention Ratio Formula Calculator

You can use the following this Retention Ratio Calculator

Retention Ratio Formula in Excel (with excel template)

Let us now do the same example above in Excel. This is very simple. You need to provide the two inputs of Dividend and EPS. You can easily do the Retention ratio calculation in the template provided.

Below is another example taking a comparison of 2 companies for improved understanding:

You can download this Retention ratio template here – Retention Ratio Excel Template

Conclusion

It is necessary to understand the investor expectations and capital requirements vary from one industry to another. Thus, comparison of plowback ratios will make sense when the same industry and/or companies are being made. There is no specific bracket within which the retention ratio should fall into and various other factors have to be considered before arriving at a conclusion pertaining to the future opportunities of a company. It should be considered just an indicator of possible intentions made by the company.

Retention Ratio Formula Video

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This has been a guide to Retention Ratio Formula, practical examples, and Retention Ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –

• Formula of Net Cash Flow
• Calculate Ratio in Excel Formula
• Exaplantion of Retained Earnings Formula
• Earnings per Share Formula
• Retained Earnings Formula
• Best Financial analysis guide
• Dividends per Share Formula
• Dividend Payout Calculator
• Dividend Yield Ratio

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