Retention Ratio vs. Dividend Payout Ratio: What’s the Difference

When companies earn profits, they must choose how to allocate them—either distribute to shareholders or reinvest in the business. The dividend payout ratio reflects the portion paid out, while the retention ratio shows what’s kept for growth.

Profit allocation influences both a company’s growth and shareholder value. Striking the right balance supports expansion while assuring investors of stability and future potential.

The dividend payout ratio is the percentage of net income a company distributes to shareholders as dividends.

Formula:
Dividend Payout Ratio = (Dividends Paid / Net Income) × 100

Example 1:
If a company earns ₹10 Crores and pays ₹4 Crores in dividends, the dividend payout ratio is 40%.

Example 2:
If a company earns ₹5 Crores and pays out ₹1 Crore, the payout ratio becomes 20%, indicating a more conservative distribution policy.

A rising payout trend over time may suggest a shift towards rewarding shareholders more generously.

The retention ratio, also called the plough-back ratio, measures the portion of earnings retained by the company to fund future operations or growth.

Formula:
Retention Ratio = (Retained Earnings / Net Income) × 100
Or,
Retention Ratio = 100 – Dividend Payout Ratio

Example 1:
If the dividend payout ratio is 40%, the retention ratio is 60%.

Example 2:
If a company retains ₹6 Crores from ₹10 Crores in net income, the retention ratio is 60%.

A declining retention ratio over time might indicate a maturing business model or less aggressive expansion plans.

The following table shows the difference between dividend payout ratio and retention ratio:

• Assess growth strategy: A high retention ratio indicates the company is focusing on reinvestment.
  

• Evaluate income prospects: A high payout ratio may appeal to income-focused investors.
  

• Compare industry norms: Different sectors follow varying payout and retention trends.
  

• Understand risk: High retention ratios can pose a risk if earnings are not reinvested wisely.
  

• Consider tax impact: Dividends may be taxed differently from capital gains, influencing investor preference.
  

• Buyback potential: Companies with high retained earnings might use them for share buybacks, boosting shareholder value indirectly.
  

 

• Technology Startups: These companies often reinvest most of their earnings into R&D, reflecting high retention ratios.
  

• Utility Firms: Due to predictable earnings and low capital needs, these firms typically exhibit high dividend payouts.
  

• FMCG and Pharma: These sectors often strike a balance, maintaining moderate payout and retention to reward investors while supporting innovation and marketing.
  

 

Analysts use these ratios to judge a company's profitability, dividend stability, and growth potential. For example:

• A tech company might retain most earnings to fund R&D.
  

• A utility company may pay out most profits due to stable earnings and low capital needs.
  

Retention Ratio and ROE

Retained earnings contribute directly to the equity portion of a company. A high retention ratio coupled with low return on equity (ROE) may indicate inefficient capital use. Investors prefer companies that generate strong ROE from retained profits, signalling good financial management.

These ratios reveal how a company balances investor returns with future growth. Striking this balance often reflects financial discipline and long-term strategy.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.