======Reinvested Earnings======
Reinvested Earnings (also known as '[[Retained Earnings]]') is the portion of a company's [[profit]] that is kept by the business for its own use, rather than being paid out to [[shareholders]] as [[dividends]]. Think of it as a company's savings account, which it can use to fund future growth. Imagine you own a successful bakery. At the end of the year, after paying for flour, sugar, and your salary, you have $10,000 left in profit. You could take that money home (a dividend) or you could use it to buy a bigger, better oven to bake more bread and make even more profit next year. That $10,000 you put back into the bakery is its reinvested earnings. This figure is a cumulative total of all profits the company has retained throughout its history and can be found on the [[balance sheet]] under shareholder's equity. For value investors, a company’s ability to generate and wisely reinvest earnings is one of its most important superpowers.
===== Why Should an Investor Care? =====
Reinvested earnings are the primary engine of a company's growth. They are the fuel that allows a business to expand, innovate, and become more valuable over time without having to borrow money (taking on [[debt]]) or selling more stock (diluting existing owners). A company that can consistently generate substantial profits and reinvest them effectively is building wealth for its shareholders from the inside out. It's a sign of a healthy, self-sustaining business. Conversely, if a company has negative retained earnings, it means its cumulative losses have exceeded its cumulative profits, which is a significant red flag for any investor.
==== The Magic of Compounding ====
This is where reinvested earnings truly shine. When a company reinvests its profits and earns a high rate of return on that new investment, it sets in motion the powerful force of [[compounding]]. [[Warren Buffett]] describes this as a "snowball" of capital that grows larger as it rolls downhill.
Let's say a company, 'Widget Co.', has $1 million in equity and earns a 20% [[Return on Equity (ROE)]], which is $200,000 in profit. If Widget Co. decides to reinvest all of that profit, its equity base for the next year is now $1.2 million. If it once again earns a 20% ROE, its profit will be $240,000 ($1.2 million x 0.20). By reinvesting again, its equity grows to $1.44 million. This snowball effect, where earnings from previous earnings generate even more earnings, can create enormous long-term value for shareholders, all powered by the simple decision to reinvest profits.
==== What Does Management Do with the Money? ====
A company's management team (the "capital allocators") has several options for deploying its reinvested earnings. The choices they make are critical to the company's future success. Common uses include:
  * **Organic Growth:** Investing in research and development (R&D), building new factories, opening more stores, or upgrading technology. This is often the most value-creating use of capital if the business has a profitable core operation.
  * **Acquisitions:** Buying other companies to gain market share, technology, or new products. While potentially transformative, [[Mergers and Acquisitions]] are notoriously tricky and can destroy value if the price paid is too high or the integration fails.
  * **Paying Down Debt:** Using cash to reduce liabilities strengthens the balance sheet, lowers interest expenses, and reduces financial risk.
  * **Share Buybacks:** The company can use its cash to buy its own stock from the open market. A [[Share Buyback]] program reduces the number of outstanding shares, which increases the ownership stake of the remaining shareholders and can boost [[Earnings Per Share (EPS)]].
===== The Value Investor's Perspective =====
A true value investor doesn't just cheer for a company that retains its earnings. The critical question is: **How well is that money being reinvested?** Keeping cash is pointless if management can't earn a good return on it. If a company can't find investment opportunities that generate returns higher than what shareholders could achieve on their own, it should return the money to them via dividends or buybacks. The skill of the management team in allocating this retained capital is a primary focus of analysis for value investors.
=== Assessing Management's Skill ===
So, how can you tell if management is a skilled capital allocator? You look at the returns they generate on the money they keep. The key metric here is the [[Return on Invested Capital (ROIC)]]. This ratio tells you how much profit the company generates for every dollar of capital it invests in its operations.
A company that consistently generates a high ROIC (say, over 15%) is demonstrating that it has a strong competitive advantage and a management team that knows how to invest for profitable growth. This is the hallmark of a "compounding machine" – the kind of business that can turn small amounts of reinvested earnings into vast fortunes for its long-term owners.