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The Plowback ratio is a measure of the amount of profit kept in a company instead of distributed to investors. Smaller companies generally have greater plowback ratios. Faster-growing companies tend to focus more on the growth of their businesses. Businesses that are more mature aren’t so dependent on reinvesting profits to increase their operations. It is 100 percent for firms who don’t pay dividends and zero for businesses which pay their total net earnings in dividends.
The plowback ratio is the amount of earnings retained that could possibly be dividends. Higher retention ratios reflect management’s belief in high growth rates and favorable economic conditions. Lower plowback ratio calculations indicate an apprehension about future opportunities for growth in business or satisfaction with cash balances.
The plowback rate is an effective metric for determining which companies invest in. Investors who favor cash distributions stay away from businesses with high plowback ratios. Companies that have higher plowback ratios may be more likely to enjoy capital gains, which are realized through appreciation in stock prices over the expansion of the business. Investors view the stability of plowback ratios as a sign of stable decisions that help to shape the future outlook.
The ratio is usually higher for companies in growth which are experiencing rapid growth in profits and revenues. A growing company will prefer to invest the profits back into its operations if they believe that it will be able to benefit shareholders by boosting profits and revenues at a much faster rate than they could by investing their dividend income.
Impact of Management
Since management decides the amount of dividends that are issued and the management’s influence directly affects on the ratio of plowback. Additionally in the calculation, the plowback rate requires using EPS that is influenced by the company’s choice of the accounting method.
A retention ratio can be described as a different concept of that of the ratio for dividends. A dividend payout ratio measures the proportion of profits by a business that it pays to shareholders. It is simply calculated as dividends per share multiplied by the earnings per share (EPS). In an example from the Disney example above for example, the ratio of payout of $0.84/$5.73 = 14.66 percent. This is obvious since you’re aware that a firm retains any money isn’t paid out. Of its total net profit in the amount of $8.98 billion Disney is expected to pay 14.66 percent and keep 85.34 percent.