Retained Earnings

Retained Earnings is the part of Net Income not paid to Shareholders as a Dividend. Held in Shareholders Funds and can be used for future capital expenditures.

Net Income can be either paid out to Shareholders as dividends or retained within Shareholders Equity as Retained Earnings. Thus, Shareholders still own the earnings retained by a Company. The Retained Earnings are part of the Capital Base and can be used by the Company for future investment. What’s best? If a Company has a high CAPEX spend due to either future growth prospects or a need to upgrade fixed assets of the Company, the Company may choose to limit the Dividend. This is a decision taken by the Board of Directors to limit dividend payments. This decision must be communicated clearly to investors.

This is possibly oversimplifying the question, but the Rule of Thumb is essentially this. If a Company can put Capital to effective use and produce a Return on Equity higher than other competing Investment opportunities, then reinvest in the business. Higher Retained Earnings will avoid or limit the need for a potentially dilutive issue of new Shares or an increase in Debt Financing. If a Company is a mature Company, with a high cash producing business, for example Utilities and covers Maintenance CAPEX. Reward Shareholders with a Dividend. In a Stock Portfolio the decisions are more complex, but this gives a general idea of what to look for.