Correct Answer:
C. Retained earnings / Earnings after tax
The retention ratio is a key financial metric that indicates how much of a company's net income is kept within the business for reinvestment, rather than being distributed to shareholders as dividends. It is a crucial measure for assessing a company's growth strategy and its ability to fund future expansion internally. A higher retention ratio suggests that a company is reinvesting a larger portion of its earnings, potentially leading to future growth.
- C: Retained earnings / Earnings after tax is the correct formula for the retention ratio. It directly measures the proportion of net income (earnings after tax) that is retained.
- A: Dividends / Earnings is the formula for the dividend payout ratio, which is the inverse of the retention ratio. It shows the percentage of earnings paid out as dividends.
- B: Retained earnings / Total equity is a component of the equity structure but does not represent the retention ratio.
- D: Earnings / Share price is the earnings yield, which is the inverse of the price-to-earnings (P/E) ratio, indicating earnings per dollar of market value.
The retention ratio is vital for investors and analysts to understand a company's capital allocation strategy and its potential for sustainable growth.