how to calculate the retention ratio
the formulas for the retention ratio are retention ratio retained earnings net income begin aligned text retention ratio frac text retained earnings text net income end aligned retention ratio net incomeretained earnings or the alternative formula is retention ratio net income dividends distributed net income begin aligned text retention ratio frac text net income text dividends distributed text net income end aligned retention ratio net incomenet income dividends distributed there are two ways to calculate the retention ratio the first formula involves locating retained earnings in the shareholders equity section of the balance sheet the alternative formula does not use retained earnings but instead subtracts dividends distributed from net income and divides the result by net income special considerationsthe retention ratio is typically higher for growth companies that are experiencing rapid increases in revenues and profits a growth company would prefer to plow earnings back into its business if it believes that it can reward its shareholders by increasing revenues and profits at a faster pace than shareholders could achieve by investing their dividend receipts investors may be willing to forego dividends if a company has high growth prospects which is typically the case with companies in sectors such as technology and biotechnology the retention rate for technology companies in a relatively early stage of development is generally 100 as they seldom pay dividends but in mature sectors such as utilities and telecommunications where investors expect a reasonable dividend the retention ratio is typically quite low because of the high dividend payout ratio the retention ratio may change from one year to the next depending on the company s earnings volatility and dividend payment policy many blue chip companies have a policy of paying steadily increasing or at least stable dividends companies in defensive sectors such as pharmaceuticals and consumer staples are likely to have more stable payout and retention ratios than energy and commodity companies whose earnings are more cyclical limitations of using the retention ratioa limitation of the retention ratio is that companies that have a significant amount of retained earnings will likely have a high retention ratio but that doesn t necessarily mean the company is investing those funds back into the company also a retention ratio doesn t calculate how the funds are invested or if any investment back into the company was done effectively it s best to utilize the retention ratio along with other financial metrics to determine how well a company is deploying its retained earnings into investments as with any financial ratio it s also important to compare the results with companies in the same industry as well as monitor the ratio over several quarters to determine if there s any trend real world examplebelow is a copy of the balance sheet for meta meta formerly facebook as reported in the company s annual 10 k which was filed on jan 31 2019 the reason the retention ratio is so high is that the tech company has accumulated profit and didn t pay dividends as a result the company had plenty of retained earnings to invest in the company s future a high retention ratio is very common for technology companies 