value
Retained earnings must earn their keep
The rule
Profit a company keeps instead of paying out must earn a good return. If it cannot, that money should go back to owners.
Where it flips
But forcing payouts from a company that reinvests at truly high returns kills the best compounding there is. The fix is to let a management keep profit only where it clearly turns it into more value.
Every rupee of profit the management keeps is a rupee it is choosing to reinvest for you. That is good only if it earns more than you could earn elsewhere. If they pour kept money into weak projects or empire-building, it quietly destroys your value. So judge a management by what its kept profit turns into.
A worked example
A firm keeps ₹500 crore of profit over five years, but its per-share value hardly moves. The money went into low-return expansion. Owners would have been richer if it had simply been paid out as dividends. [illustrative]
How to spot it
- ·profit kept, but per-share value stuck
- ·money reinvested at low returns
- ·growth for size, not for returns
Benjamin Graham · The Intelligent Investor