Insufficient Growth At Definity Financial Corporation (TSE:DFY) Hampers Share Price

When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") above 15x, you may consider Definity Financial Corporation (TSE:DFY) as an attractive investment with its 11.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With earnings growth that's superior to most other companies of late, Definity Financial has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

View our latest analysis for Definity Financial

Keen to find out how analysts think Definity Financial's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Any Growth For Definity Financial?

There's an inherent assumption that a company should underperform the market for P/E ratios like Definity Financial's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 74% gain to the company's bottom line. The latest three year period has also seen an excellent 99% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 25% over the next year. That's not great when the rest of the market is expected to grow by 22%.

With this information, we are not surprised that Definity Financial is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Definity Financial's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Definity Financial's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Definity Financial you should know about.

Of course, you might also be able to find a better stock than Definity Financial. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.