Plowback Ratio

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Plowback Ratio
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Plowback ratio (also known as redemption ratio) is determined as a proportion of the business's current earnings that are reinvested – not pay out as dividends to shareholders and not withdrawn to be used for personal consumption by owners [1] (expressed as a percentage). As a result, the plowback ratio is the opposite of the dividend payout ratio. According to Larry J. Kasper, the firm's current earnings have to be defined as ‘’ the maximum amount that could be paid as dividends without depleting its productive capacity. Thus it is net of the funds required to be reinvested to maintain the current level of productive capacity” [2].

Plowback ratio equation

Plowback ratio may be calculated using many different options as follows [3] [4]:

  • Retention (plowback) ratio = Addition to retained earnings / Net income
  • Retention (plowback) ratio = 1 – (Annual Dividend Per Share / Earnings Per Share)
  • Retention (plowback) ratio = Net Income - Dividends / Net Income
  • Retention (plowback) ratio = 1 − Dividend Payout Ratio

Importance of plowback ratio

There are many useful information which plowback ratio can show, not only related to investors and management [5] [6] [7]:

  • The higher the plowback ratio, the more of net income is reinvested in the business.
  • A decrease in the plowback ratio may mean that the proportions of a company's returns through capital appreciation have been accepted by the investors.
  • Plowback ratio may represent management's belief in business economic conditions.
  • Plowback ratio may be a clue for investors because it shows what a company invests in.
  • Plowback ratio may lead to a decrease in the company's market valuation.
  • High plowback ratio is usually observed in a dynamic businesses, which expect high-growth periods in the future.
  • Low plowback ratio is typical for old and well-established businesses, in which growth expectations can be predictable.

Footnotes

  1. Moss C. B. (2013) p.104
  2. Kasper L. J. (1997) p. 40
  3. Parrino R. (2018) p. 18-29
  4. Kasper L. J. (1997) p. 40-43
  5. Moss C. B. (2013) p.104
  6. Sarkis K. J. (2003) p. 188
  7. Kumar N. (2002) p. 62

References

Author: Weronika Kaca

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