Researching Risks Before Investing Retirement Planning

Restricted and Unrestricted Earnings

All earnings are not created equal. In many businesses -- particularly those that have high asset/profit ratios -- inflation causes some or all of the reported earnings to become ersatz. The ersatz portion -- let's call these earnings "restricted" -- cannot, if the business is to retain its economic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas: its ability to maintain its unit volume of sales, its long-term competitive position, its financial strength. No matter how conservative its payout ratio, a company that consistently distributes restricted earnings is destined for oblivion unless equity capital is otherwise infused. Restricted earnings are seldom valueless to owners, but they often must be discounted heavily. In effect, they are conscripted by the business, no matter how poor its economic potential. Unrestricted earnings should be retained only when there is a reasonable prospect -- backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future -- that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.