The particular plowback ratio measures how much earnings that have been retained after investor dividends have been paid out. It’s used by investors to evaluate the ability of any business to pay out dividends. The plowback ratio estimate is:
1 – (Annual aggregate dividends per share / Annual earnings per share)
For instance, if an industry pays out $1.00 per share and its earnings per share in the similar year were $1.50, then its plowback ratio would be:
1 – ($1.00 Dividends / $1.50 Earnings per share) = 33%
If the plowback ratio is high, this possesses different implications, depending on the circumstances. Possible scenarios are:
High development. When a business is growing at a speedy rate, there must be a high plowback percentage, since all achievable funds are needed to cover more working money and fixed advantage investments.
Low development. When a business is growing at a slow rate, a substantial plowback ratio is counterproductive, since it means the business cannot utilize the funds, and could be better off returning the cash to investors.
The range of the plowback ratio will attract different types of investors. An income-oriented investor should see a reduced plowback ratio, since this means that most earnings are paid out to investors. A growth-oriented investor are going to be attrached to a superior plowback ratio, since this means that a business has profitable internal uses because of its earnings, which will increase the stock selling price.
When the plowback ratio is near 0%, there is an elevated risk that the company will not be able to keep its current level of dividend distributions, mainly because it is diverting in essence all earnings returning to investors. This leaves no cash to compliment the ongoing capital needs from the business.
A means dilemma with the plowback ratio is that earnings per share do not essentially equate to cash flow per share, so that the amount of cash obtainable to be paid out as dividends does not constantly match the amount of earnings. This means that the board of directors may not always have the cash available to pay dividends that is indicated by the earnings per share form.