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What is a Retention Ratio?

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  • Written By: N.M. Shanley
  • Edited By: Michelle Arevalo
  • Last Modified Date: 11 November 2016
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Most often, retention ratio refers to the percentage of a company’s earnings that are not paid out as dividends to stockholders and are held back by the company. The earnings that are reinvested in the business are called retained earnings or retained capital. To calculate the ratio, a person can deduct the dividends from the company’s net income, and divide that total by the net income.

Investors are interested in learning a company’s retention ratio because a higher ratio means that more money is put back into the company. This can mean the company is poised for growth. Retained earnings can also be held back to pay for planned expenses, such as purchasing a building or new equipment. Since money is plowed back into the business, this percentage is sometimes called the plowback ratio.

Investors can use the retention ratio to calculate the maximum sustainable growth rate of a company. This growth rate is determined by multiplying the company’s return on equity by the ratio. The return on equity can usually be found in the company’s annual report. The maximum sustainable growth rate can be a factor when an investor decides whether or not to invest in a particular company.

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A low retention ratio means that more money is paid out to stockholders. Investors looking for stocks to provide income generally look for companies with lower ratios. Companies with a history of such low numbers usually try to maintain these ratios, since investors come to expect dividends each year.

The term can also refer to a customer retention or insurance retention. When applied to customers, this number is the percentage of those that keep purchasing products and services from a particular company. A high figure can indicate quality goods or service. In other words, a high customer ratio equals satisfied customers.

Insurance retention ratio is the amount of business an insurance company retains. This is calculated based on premiums, or the amount each person pays for insurance coverage. Paid premiums represent sales. In insurance, this ratio is the percentage of invoiced, or written, premiums compared to the number of premiums that are actually paid, called gross premiums.

While number can refer to different numbers in various industries, it maintains a common theme. Retention refers to something a company keeps. Retention can refer to sales, customers, or earnings, depending on the context in which ratio is used.

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goldenbears
Post 6

I never fully understood why or how someone could make investing in the stock market a full time job, or their sole source of income. Perhaps someone could enlighten me.

It is so uncertain, and as our current recession shows, you could potentially lose all of your money in just one day.

Even to make enough money to survive on, you would have to have thousands of shares spread across a variety of industries. Dividends don't pay that much or that often, so you would need a large amount of stock invested in numerous companies to make a respectable living. It takes money to make money in the stock market.

SuperJD
Post 5

If you are saving for retirement, like I am, then the best way to earn the highest rate of return over a 20 or 30 year period is to invest in growth companies.

By growth companies, I mean those that are in growing business or emerging markets, like green tech and renewable energy.

However, in order to make money in these companies, you can not think about short term returns. Most growth companies will have a high retention ratio and give out little to no dividends. Don't be discouraged by this. If you give your investment the time that it needs to grow, it can pay off handsomely for you.

sehiggins
Post 4

@nextcorrea - I agree with you. Figuring out which companies to invest in can be a challenge. In my personal finances classes as an undergraduate, my professor gave me some tips to determine what kind of companies you should invest in based on your investment goals.

If you are a young person, or looking to make some long term investments, then companies with a high retention ratio would be the best to invest in. Because they reinvest their money back into themselves, chances are their stock will go up in price over time, increasing your overall rate of return.

If you are looking to make money as soon as possible, then low retention ratio companies is the way to go. The most immediate money that can be earned is dividends, so it's best to look for stocks that give out the most of them.

truman12
Post 3

I wonder how companies determine their own retention ratios? It seem like they would have to strike a very delicate balance between investing in themselves and returning money to their investors. This would have both a practical and a strategic component. I'm glad I don't have to be the corporate accountant to have to make these decisions.

chivebasil
Post 2

It frustrates me to no end that a company can have a low retention rate as it applies to customers and still be successful. I am thinking specifically about internet companies. I know that in my are there are only 2 companies which offer high speed internet. Both of them are terrible. The price is high, the internet is slow and the customer service of both companies makes me want to pull my hair out. At various times I have used both companies and at various times I have relished in firing both companies.

Neither internet provider has done a thing to offer a quality service or to make an effort to retain their customers. This is because there

is so little competition that they know that people will turn to them no matter how bad the service is. They can have a terrible retention rate, and terrible rating across the board, and still be a profitable, well respected business. Don't let anyone tell you that the free market corrects its own mistakes.

nextcorrea
Post 1

I can imagine how confusing it would be to analyze retention ratios if you are an investor. Which do you prioritize, a company which invests in itself or one which returns a high dividend to its stock holders. It seems like there would be so many factors to weigh.

On the one hand, a company that retains a large share of its profits may be poised to grow or re-brand or to offer some exciting new product or service. Investment in oneself is investment in the future and a sign of a possibly higher future stock price.

But on the other hand, a high dividend payment means an immediate return for the investor. The point of investing is ultimately to make money. A company which retains a high percentage of its profits may not be as appealing to investors.

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