Earnings Working Against Fairfax Financial Holdings Limited's (TSE:FFH) Share Price

Fairfax Financial Holdings Limited's (TSE:FFH) price-to-earnings (or "P/E") ratio of 6.5x might make it look like a strong buy right now compared to the market in Canada, where around half of the companies have P/E ratios above 15x and even P/E's above 31x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With earnings that are retreating more than the market's of late, Fairfax Financial Holdings has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

Check out our latest analysis for Fairfax Financial Holdings

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Is There Any Growth For Fairfax Financial Holdings?

The only time you'd be truly comfortable seeing a P/E as depressed as Fairfax Financial Holdings' is when the company's growth is on track to lag the market decidedly.

Retrospectively, the last year delivered a frustrating 13% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 59% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Looking ahead now, EPS is anticipated to slump, contracting by 19% per annum during the coming three years according to the five analysts following the company. With the market predicted to deliver 9.6% growth per year, that's a disappointing outcome.

With this information, we are not surprised that Fairfax Financial Holdings 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Fairfax Financial Holdings' 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. It's hard to see the share price rising strongly in the near future under these circumstances.

It is also worth noting that we have found 2 warning signs for Fairfax Financial Holdings (1 is concerning!) that you need to take into consideration.

If you're unsure about the strength of Fairfax Financial Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.