Plowback Ratio

What is Plowback Ratio?

Plowback ratio also called a retention ratio, is the ratio of the remaining amount after the dividend is paid out and the net income of the company. A company which pays a 20 million USD dividend out of 100 million USD net income, has a plowback ratio of 0.8

This ratio is an indicator of the quantum of profit retained in a business instead of being paid out to the investors. It generally represents the portion of retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more, which could have been distributed in the form of dividends. For instance, a firm having a Plowback of say 1.5% indicates that very less or no dividend has been paid, and most of the profits have been retained for business expansion.

We note from below that Amazon and Google have a Plowback of 100% (they retain 100% of profit for reinvestments), whereas Colgate’s Plowback is 38.22% in 2016.

Retention-Plowback-Ratio

Plowback Ratio Formula

This ratio is the opposite of the Dividend Payout RatioDividend Payout RatioThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company's net income. Formula = Dividends/Net Incomeread more calculated as:

1 – (Annual Dividend Per Share / Earnings Per Share)

Plowback Formula

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Plowback Ratio (wallstreetmojo.com)

Let us assume Company ‘A’ reported earnings per share of $10 and decided to pay $2 in dividends. With the above ratio, the Dividend pay-out ratio is: $2 / $10 = 20%

This means Company ‘A’ distributed 20% of its income in dividends and re-invested the rest back in the company, i.e., 80% of the money was ploughed back in the company. Thus,

Plowback formula = 1 – ($2 / $10) = 1- 0.20 = 0.80 = 80%

This formula indicates how much profit is getting re-invested towards the development of the company instead of distributing them as returns to the investors.

  • Higher Plowback is normally followed by Fast-growing and dynamic businesses that have a belief of supportable economic conditions and persistent high-growth periods.
  • Matured businesses generally adopt a lower level of plowback, indicating sufficient levels of cash holdings and sustainable business growth opportunities.

Impact

The size of the plowback ratio will attract different types of customers/investors.

  • Investors who are income-oriented would expect a lower plowback, as this suggests high dividend possibilities to the shareholders.
  • Growth-oriented investors will prefer a high plowback implying that the business/firm has profitable internal usage of its earnings. This, in turn, would push up the stock prices.

When the plowback ratio is close to 0%, there is a large possibility that the firm would be unable to maintain the current level of dividend distributions, as it is distributing all returns back to the investors. Thus, sufficient cash is not available to support the capital requirements of the business.

One of the key issues with the plowback is that earnings per share do not necessarily match the cash flow per share so that the amount of cash available to be paid out as dividends does not always match the number of earnings. This indicates that the board of directors may not always have the cash available to pay dividends that are indicated by the EPS figure.

Let us consider another example taking a comparison of 2 companies with the help of the plowback formula for better understanding:

Company ‘A’Company ‘B’
EPS for Previous Year $3.5 $8.5
Dividends paid in the previous year per share$3.0 $1.5
Industry UtilitiesTechnology
Net Cash Flow from Investment activitiesPositiveNegative

Answer:

Plowback for Firm ‘A’ = [Dividend / EPS] = $3.0 / $3.5 = 85.71%

Plowback for Firm ‘B’ = $1.5 / $8.5 = 17.65%

The plowback of Company ‘A’ suggests that they have been struggling to find any profitable opportunities. Perhaps, the firm does not have many opportunities at the moment and thus will be distributing a reasonable portion of its earnings as dividends. This could also be a temporary tactic to keep a current lot of shareholders satisfied and enhance stock price for the immediate future.

With respect to Company’ B’, a lower Plowback and negative cash flows highlight the fact that they have been heavily investing in futuristic projects and perhaps may have retained sufficient earnings for future opportunities.

Apple – Plowback Ratio Analysis

Let’s look at a practical example to understand Plowback better –

Apple-Retention-Plowback-Ratio

source: ycharts

Items20122013201420152016
Dividends ($ bn)2.4910.5611.1311.5612.15
Net Income ($bn)41.7337.0439.5153.3945.69
Dividend Payout Ratio6.0%28.5%28.2%21.7%26.6%
Plowback Ratio94.0%71.5%71.8%78.3%73.4%

Until 2011, Apple didn’t pay any dividend to its investors, and their Plowback was 100%. Because they believed that if they reinvested the earnings, they would be able to generate better returns for the investors, which they did eventually. However, they started reducing their Plowback ratio from 2012. Apple has been maintaining a retention ratio in the 70-75% range in the past four years.

Stable Plowback Ratio of Global Banks

Global banks are big banks with a large market cap with a stable growth rate.

S. NoNamePlowback Ratio (Annual)
1JPMorgan Chase65.70%
2Wells Fargo58.80%
3Bank of America76.60%
4Citigroup84.70%
5Royal Bank of Canada52.00%
6Banco Santander62.80%
7The Toronto-Dominion Bank56.80%
8Mitsubishi UFJ Financial68.70%
9Westpac Banking27.40%
10Bank of Nova Scotia49.40%
11ING Group49.30%
12UBS Group1.20%
13BBVA54.00%
14Sumitomo Mitsui Financial71.00%
  • We note that most global banks have a very stable Plowback ratio policy.
  • JPMorgan has a Plowback of 65.70%, whereas that of UBS Group is only 1.20%.

Internet Companies – 100% Plowback

Most of the Tech Companies are high growth firms, and they prefer investing the profit generated in their products. Below are the tech companies with their Plowback ratio as 100%.

S. NoNamePlowback Ratio (Annual)
1Alphabet100%
2Facebook100%
3Baidu100%
4JD.com100%
5Altaba100%
6Snap100%
7Weibo100%
8Twitter100%
9VeriSign100%
10Yandex100%
11IAC/InterActive100%
12Momo100%

Advantages

  • One of the biggest advantages of this ratio is that the plowback ratio is relatively easy to understand and decipher.
  • There are multiple ways of calculating this ratio since many plowback formulae can be used.
  • The ratio can work in tandem with the dividend payout ratio to understand the future intentions of the company.

Disadvantages

  • The growth of the firm cannot be ascertained exclusively with the use of this ratio but also the performance of the other sectors of the company, which is being analyzed. One is also required to keep in mind the growth rate of other sectors that are part of the company and plowback the money accordingly.
  • The higher the plowback, the growth prospects of the businesses increase accordingly. This, in turn, can create an artificial increase in share prices. This can be an area of concern since the shareholders might want to control their shares and finances they have invested in the firm. Thus, a situation of panic can be created.

Conclusion

It is necessary to understand the investor expectations and capital requirements vary from one industry to another. Thus, a comparison of plowback ratios will make sense when the same industry and/or companies are being made.

There is no fixed definition of ‘high’ or ‘low’ ratio, and other factors will have to be taken into consideration before analyzing the possible future opportunities of the company. It is just an indicator of possible intentions made by the firm.

The Plowback ratio can change from one year to another, depending on the macroeconomic factors, firms’ earnings, volatility, and dividend payment policy. Most of the established companies follow a policy of paying stable or increasing dividends.

Companies in the defense sectors like pharmaceuticals and consumer staples will generally have stable pay-out and Plowback ratios in comparison to the Energy sector, whose earnings tend to be cyclical in nature.

Plowback Ratio Video

 

Recommended Articles

This article has been a guide to the Plowback Ratio Ratio. Here we discuss the formula to calculate the Plowback ratio along with practical examples, advantages, and disadvantages. Below are the other financial analysis articles that you may like –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *