Retention ratio
The share of earnings kept in the business rather than paid out, one minus the payout ratio. Multiplied by return on equity it gives the sustainable growth rate.
Where you will meet it
Retention ratio appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Use the current share price and the Gordon growth model to back out the implied dividend growth rate, and explain it
“The implied rate can be compared with a fundamental estimate such as retention ratio times return on equity.”
- Derive the main valuation inputs and value a private equity stake in venture, growth-equity and buyout deals, interpreting what the figures imply
“For later dilution, divide the required stake by the retention ratio.”
- Work out a firm's sustainable growth rate and explain it, showing how DuPont analysis can be used to estimate that rate
“Sustainable growth is the rate at which a company can grow earnings and dividends using retained earnings alone, without issuing new equity and holding its capital structure constant: g = b × ROE, where b is the retention ratio, one minus the payout ratio.”
- From forecasted fundamentals, work out a stock's justified price-to-earnings (P/E), price-to-book (P/B) and price-to-sales (P/S) ratios and explain them
“In each case growth is usually estimated as retention ratio times ROE.”
See also
Payout ratio · Return on equity
Practise it
Practise retention ratio until it is automatic: questions that explain every wrong option.
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