Retained earnings consist of accumulated net income that a company has held onto rather than paying out in dividend income or business reinvestment. Generally, increases in retained earnings are positive, though high retained earnings may be viewed negatively by shareholders at times. Retained earnings result from a combination of decisions made by company management.
You need to earn income before you retain it. An increase in retained earnings typically results only when a company takes in more money in revenue than it pays out in expenses. In a given period, a retained earnings increase results when the company earns net income and elects to hold onto it. The higher your retained earnings account, the more likely your company has consistently earned income over time.
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One reason a company elects to retain earnings is to provide a safety net against unexpected expenses, such as legal fees. Thus, coinciding with net income, retained earnings would increase if company leaders elect to hold onto excess income for safekeeping as opposed to investing it immediately or paying out cash to shareholders. Usually, the greater the threats or risks of operating in an industry, the more critical it is to retain a sizable amount of earnings.
Companies that maintain a no-dividend policy are more likely to see retained earnings grow if they earn income. New companies on a growth curve often maintain a no-dividend policy to preserve as much cash as possible. This may deter investors who are looking for a stock that generates income from dividends, but investors looking to buy and hold stock for the long term often view this is as positive sign of future share price appreciation.
Older companies with major investments in assets tend to prefer to retain earnings because of the possibility of needing to replace or repair assets at any time. Older companies may be able to pay a small dividend and still see a retained earnings increase if net income is high enough. Plus, older companies tend to have less need to make major investments in growth than newer, younger companies in the same industry.