The retention ratio is the percentage of the profit that the company keeps instead of paying profits out as dividends. The retention ratio is the opposite of the payout ratio. The payout ratio + the retention ratio will equal 100%.
The retention ratio is important in showing how a company reinvests in its operations in order to grow.
There are numerous reasons that companies can have high or low retention ratios. What follows are a few possible explanations. This is not an exhaustive list.
Companies with low retention ratios:
- Value-orientated companies
- Where the board and management may own stock and pay dividends to themselves (cynical view)
- Companies that do not have any investment projects that are worth pursuing.
Companies with high retention ratios:
- High growth company; they use the money to invest in other projects.
- Companies that do not have positive cash flow or positive earnings.
YCharts uses the formula:
Retention Ratio = 1 - Payout Ratio
Another common formula is:
Retention Ratio = (Net Income - Dividends) / Net Income