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There wouldn't be many who think First National Financial Corporation's (TSE:FN) price-to-earnings (or "P/E") ratio of 13x is worth a mention when the median P/E in Canada is similar at about 11x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
With earnings that are retreating more than the market's of late, First National Financial has been very sluggish. It might be that many expect the dismal earnings performance to revert back to market averages soon, which has kept the P/E from falling. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.
Check out our latest analysis for First National Financial
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Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like First National Financial's to be considered reasonable.
Retrospectively, the last year delivered a frustrating 8.5% decrease to the company's bottom line. Regardless, EPS has managed to lift by a handy 19% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.
Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 7.5% per year over the next three years. With the market predicted to deliver 9.3% growth per year, the company is positioned for a comparable earnings result.
In light of this, it's understandable that First National Financial's P/E sits in line with the majority of other companies. It seems most investors are expecting to see average future growth and are only willing to pay a moderate amount for the stock.
The Final Word
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of First National Financial's analyst forecasts revealed that its market-matching earnings outlook is contributing to its current P/E. At this stage investors feel the potential for an improvement or deterioration in earnings isn't great enough to justify a high or low P/E ratio. Unless these conditions change, they will continue to support the share price at these levels.