Retained earnings ("RE") is how much net income a company has left over after it pays out dividends.
How can I use information about a company's retained earnings when investing?
- You can use it to gauge a company's growth potential and subsequently, the intrinsic value of the stock. Companies that retain most or all of their earnings usually reinvest their profits to grow their existing operations, hire more employees, acquire other companies, or even buy back their shares. These are usually companies that are in the growth stage of their business life-cycle. However, they are relatively riskier compared to matured blue-chip companies so they might be more suitable if you are a "growth investor" (or a risk-tolerant investor seeking for high returns through capital appreciation instead of dividends).
- Conversely, companies with low retained earnings may be attractive to investors as well, as this also means that they pay more dividend. Dividends are portions of the company's income that they distribute to their shareholders regularly. Companies that pay high dividends are usually in the maturity stage of the business life cycle. If you are relatively risk-averse and want to earn a stable dividend income, companies with low retained earnings may be a better investment option for you. Examples of blue-chip companies that typically pay high dividends include 3M, IBM, and the Coca Cola Company, all of which are components of the Dow – an index which tracks 30 of the biggest blue-chip companies in the U.S.
- However, just looking at the total retained earnings itself may not provide sufficient information about the stock. Alternatively, you should combine it with other variables such as market value, and determine how much market value the stock can capture for every dollar that the company retains. For example, during the four years between October 2019 and October 2020, Clorox's stock price rose from $150.80 to $208.73 per share. During the same period, the total retained earnings were $28.30 per share. If we divide the retained earnings from the difference in the market value, we find out that Clorox was able to create $2.05 worth of market value for every dollar of earnings it retained. Conversely, Walmart Inc.'s stock price rose from $118.10 to $139.92 in the same period and net earnings retained were $29.66 per share. In this case, Walmart was able to create $0.74 for every dollar of earnings it retained. So although Clorox had a much smaller retained earnings per share, it was able to capture a higher market value relative to Walmart.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies