Warren Buffett has on several occasions referred to the use by a company of its retained earnings as a test of company management.
- He tells us that, if a company can earn more money on retained earnings than the shareholder can, the shareholder is better off (taxation aside) if the company retains profits and does not pay them out in dividends.
- If the shareholder can achieve a higher rate of return than the company, the shareholder would be better off if the company paid out all its profits in dividends (taxation situation again excluded) so that they could use the money themselves.
- if a company can retain earnings to grow shareholder wealth at better than the market rates available to shareholders, it should do so.
- If it can’t, it should pay the earnings to shareholders and let them do with them what they wish.