Retained earnings are the portion of corporate profits that are kept, or "retained" by the business after dividends (if any) are paid to shareholders. Mathematically calculated, retained earnings would be net income minus dividends.
Equity is composed of two major portions: Stock and excess capital on the one hand (where shareholders have purchased shares from the company) and retained earnings on the other.
Retained earnings is the portion of net income that the company has not paid out to its shareholders in the form of dividends and is, instead, keeping it inside the company to reinvest into the growth of the business. When the company is losing money, then retained earnings will shrink and go negative. When the company is making money, then it will grow and be positive.
When the company repurchases shares and does not use debt to do so, it is retained earnings that are tapped. Thus the claim that buying back shares is a return of money to shareholders. However, of course, only if this is done at a discount to the intrinsic value is this a worthwhile use of funds. When stock options are rampant and the company is repurchasing shares to keep dilution under control, then it is, instead, a transfer of earnings to the option holders instead of to outside shareholders.
The retention ratio is the percentage of net income that is retained.
Also known as accumulated earnings.
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