I had an interesting discussion this morning with Dublin Stockbroker and Equity Analyst Philip O’Sullivan regarding Return on Retained Earnings ( RoRE ). The companies we discussed were non-life insurance companies FBD Holdings ISEQ:EG7, FBD.L ) and Gable Holdings ( GAH.L ).
Retained earnings are those earnings which a company keeps from post-tax profits after paying out a dividend to shareholders. Obviously the larger the dividend the smaller the retained earnings will be and vice-versa.
Those companies with a very large RoRE should not pay any dividends to shareholders as shareholders would be hard pressed to match those returns. GAH boasts a 5 year average RoRE of 33% which is definitely a top tier return. It makes sense therefore that GAH retains all of its earnings as long as a return of around 33% is generated. Notice that almost all growth stocks pay only a very small dividend or even none at all.
This is the very reason why Berkshire Hathaway has not paid a dividend as yet. Chairman Warren Buffett believes that shareholders would be ill served if Berkshire were to start paying dividends. Whilst this was definitely true in Buffett’s partnership days as well as the early days of Berkshire I am not sure if this holds true today.
In order to calculate RoRE you will need the last 5 year figures.
FBD:
| Year Ending |
Revenue (€ m) |
Pre-tax (€ m) |
EPS |
P/E |
PEG |
EPS Grth. |
Div |
Yield |
| 31-Dec-06 | 407.26 | 296.78 | 678.82¢ | n/a | n/a | +63% | 69.00¢ | 0.0% |
| 31-Dec-07 | 407.95 | 162.17 | 405.71¢ | 6.2 | n/a | -40% | 79.50¢ | 3.1% |
| 31-Dec-08 | 385.64 | (38.61) | (100.94)¢ | n/a | n/a | n/a | 40.25¢ | 5.5% |
| 31-Dec-09 | 357.24 | (34.64) | (91.59)¢ | n/a | n/a | n/a | 30.00¢ | 4.3% |
| 31-Dec-10 | 358.39 | (3.08) | (8.08)¢ | n/a | n/a | n/a | 31.50¢ | 5.1% |
GAH:
| Year Ending |
Revenue (£m) |
Pre-tax (£m) |
EPS |
P/E |
PEG |
EPS Grth. |
Div |
Yield |
| 31-Dec-07 | 6.32 | 0.51 | 0.45p | 18.6 | n/a | n/a | n/a | 0.0% |
| 31-Dec-08 | 5.91 | 0.91 | 0.74p | 5.9 | 0.1 | +64% | n/a | 0.0% |
| 31-Dec-09 | 8.00 | 1.54 | 1.26p | 10.5 | 0.2 | +70% | n/a | 0.0% |
| 31-Dec-10 | 17.02 | 2.71 | 2.31p | 7.4 | 0.1 | +83% | n/a | 0.0% |
| 31-Dec-11 | 28.42 | 3.68 | 3.01p | 7.4 | 0.2 | +30% | n/a | 0.0% |
GAH’s 5 year earnings record looks impeccable but I must caution the investor not to throw too much weight behind those figures. True earnings power should be calculated over a much longer period of 10, or even 20, years.
FBD has reported headline losses over the last 3 years. Such a scenario could lend itself to a value investment opportunity however when calculating RoRE such a showing leads to a very low or negative RoRE.
Summarising the above we can say that generally growth shares have high RoREs whilst value type shares such as Net Nets have a low RoRE. Net Nets are usually facing difficulties which suppress earnings.
A good summary of RoRE can be found here:
http://www.buffettsecrets.com/retained-earnings.htm
I will post more on this subject in the near future.
Happy Investing !