The Possibility of Reinvesting More Capital in companies with High Returns on Capital

Bear in mind that the potential for companies with high returns on capital to reinvest a lot of capital are limited, since they tend not be be very capital intensive (e.g. Nestle Malaysia and Dutch Lady).

Furthermore, the market will probably be correctly pricing such gems which are capable of obtaining high returns over time, meaning we must wait for the right moment to acquire them at a reasonable price, because they are rarely gong to come cheap.

If some of these companies with high returns on capital in attractive sectors also offer a certain amount of growth, facilitating reinvestment of capital, then we are looking at a gem, with the added benefit of being coherent with our long term investment philosophy.

If a company can reinvest with a 20% return on investment over the next 20 years and we are able to buy the stock at a reasonable price, then the return on our investment will be close to this annual 20% over 20 years.

Understanding the Statement of Stockholders' Equity

Hong Leong Bank - Return on Retained Earnings

Hong Leong Bank
Year		DPS		EPS		Retained EPS
2002		7.6		33.9		26.3
2003		27.3		39.2		11.9
2004		16.7		23.3		6.6
2005		16.7		31.7		15
2006		16.7		33.6		16.9
2007		17.1		41.3		24.2
2008		17.3		49.4		32.1
2009		17.4		60.3		42.9
2010		17.4		65.7		48.3
2011		18		73.1		55.1
2012
Total		172.2		451.5		279.3
From	2002	to	2011
EPS increase (sen)				39.2
DPO				38%
Return on retained earnings				14%
(Figures are in sens)

KPJ - Return on Retained Earnings

KPJ
Year		DPS		EPS		Retained EPS
2002		2.2		2.5		0.3
2003		1.6		4.6		3
2004		1.4		5		3.6
2005		1.6		5.5		3.9
2006		2.5		5.6		3.1
2007		5.5		11.5		6
2008		4		12.4		8.4
2009		5.2		17.6		12.4
2010		4.9		21.2		16.3
2011		11.2		22.5	P	11.3
Total		40.1		108.4		68.3
2002-2011
EPS increase (sen)				20.0
DPO				37%
Return on retained earnings				29%
(Figures are in sens)

United Plantations - Return on Retained Earnings

United Plantations
Year		DPS		EPS		Retained EPS
2002		21.1		37.2		16.1
2003		19.8		45.4		25.6
2004		21.6		57.9		36.3
2005		21.6		63.9		42.3
2006		26.8		72.1		45.3
2007		25.8		86.2		60.4
2008		29.8		151		121.2
2009		37.5		129		91.5
2010		63.8		133		69.2
2011		71.2		182	P	110.8
Total		339		957.7		618.7
2002-2011
EPS increase (sen)				144.8
DPO				35%
Return on retained earnings				23%
(Figures are in sens)

Petronas Gas

Petronas Gas
Year		DPS		EPS		Retained EPS
2003		30		33.2		3.2
2004		18.6		32.4		13.8
2005		30.8		41.6		10.8
2006		35.8		49.1		13.3
2007		38.3		63		24.7
2008		42.5		55.2		12.7
2009		48.7		48.7		0
2010		50		47		-3
2011		50		72		22
Total		344.7		442.2		97.5
2003-2011
EPS increase (sen)				38.8
DPO				78%
Return on retained earnings				40%
(Figures are in sens)

Top Glove - Return on Retained Earnings

Top Glove

(Figures are in sens)

Year		DPS		EPS		Retained EPS
2002		0.6		3.5		2.9
2003		1.8		4.9		3.1
2004		2.4		7.6		5.2
2005		2.7		11		8.3
2006		3		14.6		11.6
2007		4.6		17.3		12.7
2008		5.5		18.7		13.2
2009		11		28.5		17.5
2010		16		42.4		26.4
2011		11		19.4		8.4
Total		58.6		167.9		109.3
2002-2011
DPO				35%
EPS increase (sen)				15.9
Return on retained earnings				15%

Petronas Dagangan - Return on Retained Earnings

Petronas Dagangan

(Figures are in sens)

Year		DPS		EPS		Retained EPS
2003		10.8		15		4.2
2004		7.2		19.2		12
2005		10.8		21.2		10.4
2006		14.4		50.9		36.5
2007		21.9		64.5		42.6
2008		33.5		66.6		33.1
2009		36		58.3		22.3
2010		63.8		75.8		12
2011		75		87.6		12.6
Total		273.4		459.1		185.7
From 2003-2011
DPO				0.60
EPS increase				72.60
Return on retained earnings				39%

Retained Earnings are central to the process of investment growth

A company adds up its income, subtracts its expenses, and pays any dividends due; what is left becomes retained earnings.  These are undistributed profits.

Undistributed profits or retained earnings are central to the process of investment growth.

The net worth of the company builds up through the reinvestment of undistributed earnings.

Corporate raiders in particular love to find a company with a lot of cash reserves accumulated from retained earnings.

There is a legitimate dispute over how much retained earnings are adequate, and at what level a company should let loose of some cash and distribute it to shareholders.

Overall, retained earnings like the payment of dividends, deliver a powerful message:  the company generates more cash than it needs for the operation of the business.

That's exactly what a good investment should do.  

These earnings, over and above total expenses and taxes, drive the share price higher.

Common stocks have one important investment characteristic and one important speculative characteristic.  

• Their investment value and average market price tend to increase irregularly but persistently over the decades, as their net worth builds up through the reinvestment of undistributed earnings.
• The speculative feature is no mystery.  It is the tendency toward excessive and irrational price fluctuations as investors (in Graham's words) "give way to hope, fear, and greed."

Companies amassing huge cash reserves should use these intelligently

Companies with large cash reserves can use these for the direct benefit of their shareholders by giving dividends or can deploy these to grow their businesses in the future.

Benjamin Graham was critical of amassing huge cash reserves within a business unless the company had a genuine future use for the funds.  

A certain calculable amount of reserves are necessary to:

• finance growth, 
• guard against bad luck or down cycles, 
• cover the settlement of a lawsuit, or 
• eventually replace some important asset. 

Graham argued, there is a limit to that need.  

The purpose of business is to earn profits for its owners.  Owners are entitled to access to profits.  

If earnings are retained, Graham persisted in his argument, they had better be used intelligently.

Graham contended that when corporate management is stingy with dividends or withholds them altogether, it is sometimes for self-serving reasons.  It is easier to keep the cash on hand to bail management out of bad times or bad decisions.  Sometimes the dividend policy is simply a reflection of the tax status of management and large investors - they don't want the addition to their current taxable income.  Consequently, other investors get no income.

Probably the greatest retainer of earnings of all time is Berkshire Hathaway, which keeps and reinvests all its earnings.  Berkshire's 23% return on shareholder equity is almost double that of American industry, and Buffett says he will continue to hoard earnings so as long as a dollar of retained earnings translates to no less than a dollar of increased shareholder value.  In his case, investors are inclined to let him have his way.


Comment:
It is not uncommon to encounter a company with huge cash reserves in their businesses earning only  fixed deposit interest rates for many years.  Shareholders should play their active role as business owners through raising the relevant questions to the management in the annual general meeting, to use these cash reserves intelligently.

In recent years, strong cash reserves have provoked takeover bids from corporate raiders.  Are they liberators of cash for shareholders or are they destroyers of business, interested only in their own personal enrichment?  These raiders often planned to use cash reserves to help finance their purchase, a tactic that often sucks the strength from a company.  The management may defend the cash reserve was needed for various reasons, for example, the company needed the cash to cover the next down cycle of the manufacturing business.  Corporate raiders love to find and are attracted to a company with huge cash reserves.

Statement of Owners' Equity (Statement of Retained Earnings)

The equity statement explains the changes in retained earnings.

Retained earnings appear on the balance sheet and most commonly are influenced by income and dividends.  The Statement of Retained Earnings therefore uses information from the Income Statement and provides information to the Balance Sheet.

The following equation describes the equity statement for a sole proprietorship:

Beginning Equity
+ Investments
- Withdrawals
+ Income
----------------
= Ending Equity

For a corporation, substitute "Dividends Paid" for "Withdrawals".  The stockholders' equity in a corporation is  calculated as follows:

Common Stock (recorded at par value)
+ Premium on Common Stock (issue price minus par value)
+ Preferred Stock (recorded at par value)
+ Premium on Preferred Stock (issue price minus par value)
+ Retained Earnings
------------------------------------------------------------
= Stockholders' Equity


Note that the premium on the issuance of stock is based on the price at which the corporation actually sold the stock on the market.  Afterwards, market trading does not affect this part of the equity calculation.  Stockholders' equity does not change when the stock price changes!

The Importance of Retained Earnings

The Importance of Retained Earnings
BY STOCK RESEARCH PRO • JUNE 9TH, 2009

Retained earnings, also known as “accumulated earnings” or “retained capital” refer to the portion of net income the company retains as opposed to distributing those funds to shareholders in the form of dividends. A company’s retained earnings are typically reinvested into its core business or used to pay down debt. A company’s retained earnings (or retained losses) are cumulative from year to year with losses and earnings offsetting and reported in the company’s Statement of Retained Earnings/ Losses.

Calculate Retained Earnings
The formula to calculate retained earnings can be written as:

Retained Earnings = Beginning Retained Earnings + Net Income – Dividends

The formula simply adds net income for the period (or subtracts a loss) from the beginning retained earnings and then deducts any dividends paid for the period.

Interpreting Retained Earnings

• Reinvestment of retained earnings can be an important source of financing for many companies. 
• Many creditors will closely monitor a company’s retained earnings statement because the company’s policy regarding dividend payments to its stockholders can have a direct impact on its ability to repay its debt.
• The importance of retained earnings to investors is in understanding the level to which the company reinvests its earnings to fund growth and expansion. If, however, the company reinvests retained earnings without demonstrating significant growth, investors would probably be better off if the company had issued a dividend.

The Statement of Retained Earnings
The Statement of Retained Earnings or Statement of Owner’s Equity is a basic financial statement issued by a company to outline the changes in the company’s retained earnings over the reporting period. Using net income for the period and other company financial statements, the statement reconciles the beginning and ending retained earnings for the reporting period. The statement of retained earnings uses information from the income statement and provides information to the balance sheet.


http://www.stockresearchpro.com/the-importance-of-retained-earnings

Bullbear Stock Investing Notes
http://myinvestingnotes.blogspot.com/

Retained Earnings or Reserves

Shareholders' equity: the retained earnings portion is often the largest component.

Shareholders' Equity

 

What Does Shareholders' Equity Mean?

 

A firm's total assets minus its total liabilities. Equivalently, it is share capital plus retained earnings minus treasury shares. Shareholders' equity represents the amount by which a company is financed through common and preferred shares.

 

Also known as "share capital", "net worth" or "stockholders' equity".

Shareholders' equity comes from two main sources.

• The first and original source is the money that was originally invested in the company, along with any additional investments made thereafter.
• The second comes from retained earnings which the company is able to accumulate over time through its operations. In most cases, the retained earnings portion is the largest component.

Statement of Retained Earnings

-----

SAMPLE Consolidated Statement of Retained Earnings
For the Year Ending December 31, 2002

December 31, 2002

$2,185,000   Retained Earnings Beginning of Year
$2,188,000   Net Income

$   700,000   Less Cash Dividends
$3,673,000   Balanced Retained Earnings End of Year

-----

The statement of retained earnings indicates the amount of the company's earnings (net income from the current income statement) and adds this amount to the previous retained earnings from the balance sheet.  When a company earns a profit, management must decide either to:

1.  Pay out all or part of the earnings to shareholders as dividends; or
2.  Retain the earnings to

• finance the purchase of assets,
• retire debt, or
• grow the other resources of the company.

The retained earnings on the balance sheet are the sum of undistributed earnings of the company that have accumulated over time. 

The statement of retained earnings indicates the amount of retained earnings accumulated at the beginning of the year, and then adds the net income for the period.  If management declares a cash dividend, it is deducted from retained earnings to arrive at the balance of retained earnings for the end of the year, which is carried forward to the balance sheet.

The statement of retained earnings shows you how much net income the company will retain or pay out in dividends for the year - an important factor when you are focusing on dividend-paying stocks.