Should Weakness in Universal Music Group N.V.'s (AMS:UMG) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Universal Music Group (AMS:UMG) has had a rough three months with its share price down 21%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Universal Music Group's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Universal Music Group

How To Calculate Return On Equity?

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 Universal Music Group is:

45% = €1.6b ÷ €3.5b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.45 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Universal Music Group's Earnings Growth And 45% ROE

First thing first, we like that Universal Music Group has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. Probably as a result of this, Universal Music Group was able to see a decent net income growth of 5.1% over the last five years.

We then compared Universal Music Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is UMG worth today? The intrinsic value infographic in our free research report helps visualize whether UMG is currently mispriced by the market.

Is Universal Music Group Efficiently Re-investing Its Profits?

Universal Music Group has a significant three-year median payout ratio of 79%, meaning that it is left with only 21% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Universal Music Group is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 62% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

Overall, we feel that Universal Music Group certainly does have some positive factors to consider. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.