Is It Time To Buy Fairfax Financial Holdings Limited (TSE:FFH) Based Off Its PE Ratio?
Fairfax Financial Holdings Limited (TSX:FFH) is currently trading at a trailing P/E of 8x, which is lower than the industry average of 15x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Fairfax Financial Holdings
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for FFH
Price-Earnings Ratio = Price per share ÷ Earnings per share
FFH Price-Earnings Ratio = $531.8 ÷ $66.742 = 8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FFH, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since FFH’s P/E of 8x is lower than its industry peers (15x), it means that investors are paying less than they should for each dollar of FFH’s earnings. As such, our analysis shows that FFH represents an under-priced stock.
A few caveats
However, before you rush out to buy FFH, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to FFH. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with FFH, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing FFH to are fairly valued by the market. If this does not hold true, FFH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to FFH. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for FFH’s future growth? Take a look at our free research report of analyst consensus for FFH’s outlook.
Past Track Record: Has FFH been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of FFH’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
