Yahoo Finance Are Strong Financial Prospects The Force That Is Driving The Momentum In Fairfax Financial Holdings Limited's TSE:FFH) Stock?
Fairfax Financial Holdings' (TSE:FFH) stock is up by a considerable 8.5% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Fairfax Financial Holdings' ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Fairfax Financial Holdings
How Do You Calculate Return On Equity?
Return on equity 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:
18% = US$3.6b ÷ US$20b (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.18 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Fairfax Financial Holdings' Earnings Growth And 18% ROE
To begin with, Fairfax Financial Holdings seems to have a respectable ROE. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. Probably as a result of this, Fairfax Financial Holdings was able to see an impressive net income growth of 32% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Fairfax Financial Holdings' growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Using Its Retained Earnings Effectively?
Fairfax Financial Holdings has a really low three-year median payout ratio of 14%, meaning that it has the remaining 86% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Moreover, Fairfax Financial Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 104% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 2.5%) over the same period.
Summary
On the whole, we feel that Fairfax Financial Holdings' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.
