Warren Buffett: "For every dollar retained by the corporation, at least one dollar of market value must be created for owners."

Each dollar of retained earnings is translated into at least one dollar of market

Hey guys,

Been reading the warrent buffet way book, however, I am not too sure if my understanding of the phrase below is 100% correct.

"Each dollar of retained earnings is translated into atleast one dollar of market value."

Retained earnings are the profits from the company right?

So if company X makes 100 million retained profit, they reinvested 100 million back into the company million, they would make another 100 million profit from it?

Therefore translating to at least one dollar of market value right?



Thanks heaps!!!

Not quite, retained earnings is profits from the business less any dividends paid out to shareholders, and its a component of "shareholder equity" in the balance sheet. So if a company makes $100 in total profit and pays out $20 in dividends, retained earnings would be $80.

Market value is the market cap of the company. So if the company has increased retained earnings by $80 a year you want the market cap (share price times total number of issued shares) to increase by at least $80 if not more. It is a measurement of whether or not the company's share price is keeping up with the growth of the company's earnings, and the amount by which it increases over the amount of retained earnings will reflect that company's return on equity over and above the cost of capital. 

In other words, do not buy companies whose share price is declining over the long term, as this indicates a poor return on retained earnings.


http://www.sharetrader.co.nz/showthread.php?9262-Each-dollar-of-retained-earnings-is-translated-into-at-least-one-dollar-of-market