Why investors should track how companies reinvest profits
When investors and analysts evaluate a company, they often focus on the usual headline numbers—earnings per share, profit margins and revenue growth. These are the metrics that dominate news coverage and research reports and tend to drive market excitement.
But if you’re serious about understanding a company’s long-term value, there’s one simple but powerful ratio that usually goes unnoticed. This is the retained earnings to total assets (RE/TA) ratio.
This ratio doesn’t make headlines, but it tells an important story. It shows how much of a company’s assets have been funded by profits it kept over time, not by borrowing money or issuing new shares. In other words, it reveals whether a business has built itself from the inside or relied on outside funding to grow.
The idea behind this ratio is straightforward: if a company earns money and keeps part of it to reinvest in the business, it suggests that the business can sustain itself. It doesn’t need to raise capital every time it wants to expand.
It is also less exposed to rising interest rates and doesn’t have to dilute shareholders by issuing more stock. A high RE/TA ratio tends to make a company more stable and more likely to survive during tough times.
Studies have shown that companies relying on retained earnings tend to perform better over the long run than those that depend on debt to finance growth. A 2020 study by Ray Ball of the University of Chicago, along with his co-authors, found that retained earnings play a key role in predicting future stock returns. Specifically, they observed that retained earnings—as a component of equity—have stronger predictive power than contributed capital raised through share issuance.
Another study made by Frank and Goyal in 2009 also found that companies with higher internal profits as measured through retained earnings are often valued more highly by the market.
For example, if we compare SM Investments and Ayala Corp, both companies have a similar amount of total assets—around P1.7 trillion—but SM has 64 percent more retained earnings than Ayala. This results in a higher RE/TA ratio for SM at 0.32, compared with Ayala’s 0.19. With a stronger RE/TA ratio, SM enjoys a higher valuation, trading at 1.69 times price-to-book ratio, versus Ayala’s 0.86.
By rule of thumb, a company with high RE/TA ratio—above 0.5—typically signals a strong profitability track record, low financial risk and a business that has largely financed its assets through reinvested earnings rather than debt or new equity.
A moderate ratio, between 0.1 and 0.5, suggests a balanced approach, where the company uses both internal profits and external funding to support growth.
Meanwhile, a low or negative ratio—below 0.1—may point to either a young, high-growth company still reinvesting heavily in expansion, or a financially distressed firm with accumulated losses.
If we look at the RE/TA ratios of companies listed on the Philippine Stock Exchange (PSE), we see a modest decline in the median—from 0.18 in 2019, before the pandemic, to 0.17 today.
On the surface, this drop may appear trivial. But in valuation, a lower RE/TA ratio suggests that, collectively, firms are relying more on external capital, whether debt or equity, to finance their assets, which, in turn, raises their level of financial risk.
For instance, if we survey the RE/TA ratios of PSE-listed companies, we find that the share of firms with a high RE/TA ratio of 0.5 and above has more than doubled from 4.8 percent in 2019 to 10.5 percent in 2024, which is a positive sign.
However, the proportion of companies in the moderate range has declined noticeably, falling from 65.3 percent to 51.9 percent over the same period.
As a result, the share of companies with low RE/TA ratio has risen from 29.9 percent in 2019 to 37.6 percent in 2024. This shift suggests that a growing portion of the market may be more financially vulnerable, especially in the face of tighter credit conditions or economic shocks.
This trend of declining RE/TA ratios across the market reflects not just a change in how companies are financing their growth—it also signals growing risks that could weigh on stock valuations.
As more firms rely on external capital rather than reinvested earnings, their financial resilience weakens, especially in an environment of rising borrowing costs and global economic uncertainty.
Historically, companies with lower RE/TA ratios tend to trade at lower price-to-book multiples, as investors demand a discount for the added risk. If this pattern persists, the broader market could face downward pressure on valuations. In effect, the rise in low-RE/TA firms may already be contributing to softer stock prices, particularly among businesses that lack strong internal capital generation to support sustainable growth.
