Retained Earnings. Why it matters

Retained earnings are the running tally of every dollar a company has ever earned but not paid out—its self-funded war chest.

When that balance climbs at a steady, compounding clip, it’s a neon sign that the business
(a) consistently produces surplus cash and
(b) keeps finding projects that earn more than they cost.

Those two ingredients—surplus generation and high-return reinvestment—drive an exponential flywheel of value creation: profits feed growth, growth swells profits, and so on.

By contrast, flat or choppy retained earnings usually signal a firm that either has no attractive places to put money or squanders it on low-return deals, leaving long-term shareholder returns stuck in first gear.

In short, stable retained-earnings growth isn’t just an accounting curiosity; it’s one of the clearest fingerprints of a true compounder.

How do we quantify whether it works?

Well, one way of testing stable retained earnings growth is by using our formula for long term stable growth.

Filling that in for retained earnings allows us to run a ranking backtest.

Clearly, the companies (buckets of companies) that score high on stable retained earnings growth have done much better historically than the bottom performers.

We can represent the same data more statically by only looking at the excess annualized return over the universe. 

There is no question that this metric alone - even without considering the return on invested capital - is quite valuable in determining the ability of a company to deliver year after year.

Should you search for companies with high retained earnings growth?

Most likely. Retained earnings growth is a pretty solid characteristic for any company. 

Rising retained earnings are the cleanest footprint of self-funded, high-return compounding. A company that steadily adds to its retained-earnings pool is doing two things at once.

(1) generating excess cash after covering all expenses and dividends, and

(2) reinvesting that cash into projects that earn more than they cost.

Each incremental dollar fuels the next round of growth without dilution or extra debt, so intrinsic value snowballs year after year.

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Over the last 5 years I have been making about 41% net returns. Some of my top holdings are TOT (Canadian), FAA (German), ESP, NATR and RCMT.

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