Is Fairfax Financial Holdings Limited's (TSE:FFH) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Simply Wall St · 10/14 19:52

Fairfax Financial Holdings (TSE:FFH) has had a great run on the share market with its stock up by a significant 11% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Fairfax Financial Holdings' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Fairfax Financial Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Fairfax Financial Holdings is:

17% = US$4.7b ÷ US$28b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.17 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. 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 17% 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. This certainly adds some context to Fairfax Financial Holdings' exceptional 35% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Fairfax Financial Holdings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same 5-year period.

past-earnings-growth
TSX:FFH Past Earnings Growth October 14th 2024

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Fairfax Financial Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Fairfax Financial Holdings Efficiently Re-investing Its Profits?

Fairfax Financial Holdings' three-year median payout ratio to shareholders is 8.0%, which is quite low. This implies that the company is retaining 92% of its profits. So it looks like Fairfax Financial Holdings is reinvesting profits heavily to grow its business, which shows in its earnings growth.

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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 11% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 9.5%) over the same period.

Summary

In total, we are pretty happy with Fairfax Financial Holdings' performance. 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.