Fairfax Financial Holdings' (TSE:FFH) stock up by 5.7% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Fairfax Financial Holdings'  ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Fairfax Financial Holdings

How Is ROE Calculated?

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:

15% = US$4.3b ÷ US$28b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.15 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Fairfax Financial Holdings' Earnings Growth And 15% ROE

At first glance, Fairfax Financial Holdings seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Consequently, this likely laid the ground for the impressive net income growth of 31% seen over the past five years by Fairfax Financial Holdings. However, there could also be other drivers behind this 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' growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.TSX:FFH Past Earnings Growth February 20th 2025

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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.

Story Continues

Is Fairfax Financial Holdings Using Its Retained Earnings Effectively?

Fairfax Financial Holdings' ' three-year median payout ratio is on the lower side at 8.1% implying that it is retaining a higher percentage (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.

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 16% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 6.4%, over the same period.

Summary

On the whole, we feel that Fairfax Financial Holdings' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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 freereport on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

View Comments