Return on Retained Earnings (RORE)
Explaining return on retained earnings
The return on retained earnings (RORE) is a calculation to reveal the extent to which the previous year profits were reinvested. The return on retained earnings is expressed as a percentage ratio. A higher return on retained earnings indicates that a company would be better off reinvesting the business. On the contrary, a lower return on retained earnings indicates that paying out dividends might prove to be in the company’s best interests.
As stated by Investopedia, it can generally, as an investor, be difficult to evaluate the worth of a company by just having a look at its balance sheet. A return on retained earnings computation can be helpful in assuaging some of the confusion in addition to clarifying unerringly what the numbers are trying to say. For investors, a general rule of thumb is to look for companies featuring a high return on retained earnings which is regularly reinvested.
Estimating the return on retained earnings
The main steps involved in computation of return on retained earnings are as listed below:
- Establish a dividend policy. The dividend policy affects the return looked for by a company to earn on its retained earnings. External factors, counting additional financing and investment opportunities, are helpful in delineating the dividend policy. Besides, internal conditions, like shareholders tax position, previous year’s dividends, and the liquidity of the company are also helpful in shaping the dividend policy.
- The next step is to achieve the confidence of the shareholders. Generally, the shareholders invest in a company with two basic aims – earn regular dividends, and enjoy capital gains when they dispose of company shares. Alterations in dividend policy can be a warning signal for the shareholders thus making it essential for the investors to reassure that a decrease in dividend payments indicates the company’s wish to make additional investments in the business.
- Thereafter, move ahead towards making additional investments. This requires investing time and money to research for adequate investment opportunities which are not able to earn the requisite return on shareholders’ investment.
- The final step is monitoring the company’s performance, especially the return on retained earnings ratios. Besides, it is also essential to ensure that the company practices equilibrium between its profitability and liquidity.