Return on Retained Capital

A simple mathematical formula measures the capital requirements of maintaining a company's competitive advantage and management's ability to utilize retained earnings to improve shareholders' wealth. In essense this calculation takes the amount of earnings retained by a business for a certain period and measures its effect on the earning capacity of the company.

With a durable competitive advantage the company will be able to use its retained earnings either to:

• expand its operations,
• invest in new businesses,
• and/or repurchase its shares.

All three should have a positive effect on per share earnings.

On the other hand, a price-competitive business would need to spend its retained earnings to maintain its business to the face of fierce competition from other companies in the same line of business, leaving little or nothing to invest in new operations and/or buying back its shares.

Companies that have a durable competitive advantage usually don't have to spend a high percentage of their retained earnings to maintain their operations. The key word here is maintain. In theory, the more durable a competitive advantage, the less a business has to spend to maintain it. Warren Buffett's perfect business would be one that spends zero on maintaining its competitive advantage. That would free every dollar it earns to be paid out as a dividend or reinvested in the business, which should, in theory, make its shareholders even wealthier.


Also Read:
Return on Retained Capital
Return on Retained Capital Illustrated by Various Companies
Companies that can't profitably deploy retained earnings make lousy investments
RORC provides a fast method of determining durable-competitive-advantage business