What Is the Plowback Ratio?
Let me explain the plowback ratio to you directly—it's a financial metric used in fundamental analysis that reveals the portion of a company's earnings reinvested back into the business instead of being paid out as dividends to shareholders. You might hear it called the retention ratio most often. On the flip side, the payout ratio measures the percentage of earnings distributed as dividends.
Key Takeaways
Understand this: the plowback ratio is a fundamental analysis tool that gauges how much earnings remain after dividends are paid, serving as an indicator of profit retained in the business rather than given to investors. If you see higher retention ratios, it points to management's confidence in high-growth phases and positive business conditions. Lower ratios suggest caution about future growth or contentment with current cash levels. Remember, it's commonly known as the retention rate or ratio. For companies skipping dividends entirely, the ratio hits 100%, and it's zero for those paying out all net income as dividends.
The Formula for the Plowback Ratio
You calculate the plowback ratio by subtracting the quotient of annual dividends per share divided by earnings per share (EPS) from 1. Alternatively, you can find it by looking at the funds left after figuring the dividend payout ratio. The formula is Retention Ratio = (Net Income - Dividends) / Net Income. On a per-share basis, it's 1 - (Dividends per Share / EPS). For instance, if a company reports $10 EPS and $2 per share in dividends, that's a 20% payout ratio and an 80% plowback ratio.
What Does the Plowback Ratio Tell You?
This ratio tells you exactly how much profit a business holds onto rather than paying out to investors. Younger companies often show higher plowback ratios because they're focused on development and growth. More established firms don't rely as much on reinvesting profits to expand. Again, it's 100% for non-dividend payers and zero for those distributing all net income.
You'll find the plowback ratio most helpful when comparing companies in the same industry, as different sectors handle profits differently. Take tech companies—they frequently have a plowback ratio of 100%, meaning no dividends and all profits funneled back into growth.
Essentially, the ratio represents retained earnings that could have been dividends. High ratios signal belief in strong growth ahead and good conditions, while low ones indicate hesitation on opportunities or satisfaction with cash on hand.
Investor Preference
As an investor, you can use the plowback ratio to see what companies are investing in. If you prefer cash dividends, steer clear of high plowback ratio firms. But those with higher ratios might offer better capital gains through rising stock prices as the company grows. Stable ratios suggest consistent management decisions that help predict the future.
Growth companies, especially those with surging revenues and profits, typically have higher ratios. They'd rather reinvest earnings if they think it will boost revenues and profits faster than what shareholders could get by investing dividends elsewhere.
Impact From Management
Management has a direct hand in this— they decide dividend amounts, which affects the plowback ratio. Plus, the calculation uses EPS, influenced by accounting choices. So, only a few internal variables heavily sway the ratio.
Example of the Plowback Ratio
Take this real example: On November 29, 2017, The Walt Disney Company declared a $0.84 semi-annual cash dividend per share, payable January 11 to shareholders of record December 11. For the fiscal year ended September 30, 2017, their EPS was $5.73. So, the plowback ratio is 1 - ($0.84 / $5.73) = 0.8534, or 85.34%.
This ties into the retention ratio being the opposite of the dividend payout ratio, which evaluates profits paid to shareholders. You calculate payout as dividends per share over EPS—in Disney's case, $0.84 / $5.73 = 14.66%. Logically, from $8.98 billion in net income, they pay out 14.66% and retain 85.34%.
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