What Are Retained Earnings in Simple Terms?
"Retained earnings" alludes to the portion of a company's net income that isn't distributed to shareholders as dividends. Earnings that are retained rather than distributed to shareholders might be utilized for growth and expansion activities like research and development, the purchase of new plants or equipment, or hiring.
This measurement is cumulative, so it incorporates any past retained earnings and can be recalculated any time extra earnings are retained by a company. On the off chance that a company loses money as opposed to bringing in money over a given period (i.e., their net income is negative), this cheapens any retained earnings the company had.
How Do You Calculate Retained Earnings?
To ascertain retained earnings, add any new earnings to the existing retained earnings figure, then, at that point, take away any dividends paid out of these earnings.
Retained Earnings Formula
RE = Base RE + Net Income - Dividends Paid
How Could Investors Interpret Retained Earnings?
What proportion of net income is retained versus distributed as dividends fluctuates impressively between companies based on industry, company age, and company objectives. More mature companies whose growth has eased back frequently pay higher dividends or pay dividends more consistently than more youthful companies that are extending with an end goal to secure market share.
Dividend investors — those seeking standard passive income payments — could like to invest in companies that will generally hold a smaller portion of their earnings and pay customary dividends. Growth investors — those hoping to develop their principal by however much as could be expected — could like to invest in companies that will generally hold most or all of their earnings to reinvest in company growth.
Retained earnings add to shareholder equity (how much each share of a stock is worth in real terms — not market value), which can, thus, drive stock price up. Therefore, high retained earnings are normally a decent sign to investors, particularly the people who didn't buy in specifically for dividend payments.
How Do Companies Decide How Much Profit to Retain and How Much to Pay Out as Dividends?
This relies upon a company's age and objectives. Regularly, more youthful companies reinvest most or every one of their profits into growth, while more established, more mature companies that have been turning a predictable profit for a really long time are bound to parse out a portion of their earnings to shareholders as dividends. Certain sectors and industries are more prone to pay dividends than others, and a few sectors are especially valued by dividend investors for their high average dividend yields.
Retained Earnings Example: Apple (Nasdaq: AAPL)