Fairfax Financial Holdings' (TSE:FFH) stock is up by a considerable 13% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Fairfax Financial Holdings' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Fairfax Financial Holdings is:
0.9% = US$172m ÷ US$19b (Based on the trailing twelve months to September 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Fairfax Financial Holdings' Earnings Growth And 0.9% ROE
It is quite clear that Fairfax Financial Holdings' ROE is rather low. Even compared to the average industry ROE of 12%, the company's ROE is quite dismal. Fairfax Financial Holdings was still able to see a decent net income growth of 10% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Fairfax Financial Holdings' reported growth was lower than the industry growth of 19% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Fairfax Financial Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Fairfax Financial Holdings Making Efficient Use Of Its Profits?
Fairfax Financial Holdings has a low three-year median payout ratio of 9.5%, meaning that the company retains the remaining 91% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Fairfax Financial Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 128% over the next three years. However, Fairfax Financial Holdings' future ROE is expected to rise to 1.8% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
In total, it does look like Fairfax Financial Holdings has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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