## Wednesday, 29 August 2012

### The Magic of Dutch Lady: Measuring management's ability to profitably allocate earnings.

Depicted below are the 12 years financial statistics of Dutch Lady.

Date DPS EPS Retained EPS
1999 0 15.9 15.9
2000 4.5 21.7 17.2
2001 5.8 18.7 12.9
2002 5.8 23.7 17.9
2003 12.8 24.2 11.4
2004 56 26.6 -29.4
2005 63.2 42.4 -20.8
2006 63.2 67.3 4.1
2007 42.1 73.8 31.7
2008 65.6 66.6 1
2009 72.5 94.4 21.9
2010 72.5 119 46.5
Total 464 594.3 130.3

 1999-2010 DPO 0.78 EPS increase 103.1 Return on retained earnings 79.1%

We can observe that for the last 12 years (year 1999 to year 2010), the management of Dutch Lady:

1.  has earned a total of 594.3 sen per share
2.  has distributed a total of 464 sen per share, giving a DPO ratio of 78.1%.
3.  has retained a total of 130.3 sen per share as retained earnings.
4.  has increased its EPS by 103.1 sen per share ( 119 - 15.9 = 103.1) from 1999 of 15.9 sen per share to 119 sen per share in 2010.

How do we as investors measure a company and its management's ability to profitably allocate (unrestricted) earnings?

We can do this by taking the per share earnings retained by a business for a certain period of time, then compare it to any increase in per share earnings that occurred during this same period.

Thus, the management of Dutch Lady has used the retained EPS of 130.3 sen per share to grow its earnings by 103.1 sen per share from 1999 to 2010..

Therefore, the management of Dutch Lady has earned a 79.1%( = 103.1 / 130.3) return in 2010, on the 130.3 sen a share that Dutch Lady retained from the year 1999 to 2010.
Even if we have no idea of the business of Dutch Lady, we can still safely conclude that Dutch Lady has done a great job of profitably allocating its retained earnings.

This test is not perfect.  One must be careful that the per share earnings figures used are not aberrations.  One has to make sure that the per share figures used are indicative of any real increase or decrease in earning power.

The advantage to this test is that is gives you, the investor, a really fast method of determining whether or not a company and its management have the ability to allocate retained earnings in a fashion that increases the wealth of the company's shareholders.