The amount of money you allocate for the growth of the company tells a lot about the growth potential of a company, as well as its efficiency. A higher return on retained earnings (RORE) would suggest that reinvesting in the business should be the next course.
A lower return, however, would say that you ought to distribute the profits among the shareholders – and pay out the dividends. This is generally the more appropriate option if you can’t get a good return from business growth.
Defining RORE Ratio
The return on retained earnings ratio is a fairly important tool for every investor since it can reveal a lot regarding the company’s potential for growth and efficiency. If the RORE percentage is low, then this means that there isn’t enough money for growth – which is why that money should be distributed among the shareholders.
In other words, the RORE ratio can have different effects on various groups of people. It can attract new investors who see potential growth within the company – or it can keep current shareholders happy by providing dividends. Ideally, the RORE ratio should be kept ascending – because that means higher profit in the future as well.
Applying the Formula
There are various ways for you to arrive at the RORE ratio – but the most straightforward way is to use the information made public on EPS (earnings per share) over a time of several years (ideally, five).
What interests you the most is the most recent EPS, the first period EPS, CDPP (cumulative dividends per period) and cumulative EPS per period. As a result, the RORE equation would look something similar to this:
To get a result, you have to find the earnings per share sum over a specific time period, as well as the dividends given to the shareholders within that specific timeframe. Once you have gathered that data, continue by subtracting the cumulative dividends from the cumulative EPS per period. This will be the end of the first stage.
The second one requires you to find the growth over time and the differences; you will need the EPS from start to finish – but once you have that, everything else is a breeze. Al that is left to do is take this number and divide it by the answer you got in the equation above. The answer you will get will be read as a percentage.
Final Thoughts
Learning the return on retained earnings (RORE) is certainly very useful not only for investors but for managers as well. The higher the return, the more profitable the business will look for investors. This is why the executive team needs to keep a close eye on business efficiency.
A low return, on the other hand, may signal a need for improvements to the process. If the company doesn’t get enough profit to sponsor growth, then they might want to find ways to boost the profit – regardless if it’s changing a current operation or adding a new one.